Bankruptcy and Debentures Subordinated Debentures Essay

Submitted By 786952727QqCom
Words: 1214
Pages: 5
Open Document
Week 5
Financial Distress

Topics
 What is financial distress?
 Liquidation vs. reorganization
 Meaning and simplified example

 Scoring models – the Altman Z-score

2

What is Financial Distress?
 A situation where a firm’s operating cash flows are not sufficient to satisfy current obligations and the firm is forced to take corrective action.
 Financial distress may lead a firm to default on a contract, and it may involve financial restructuring between the firm, its creditors, and its equity investors.
 Usually the firm is forced to take actions that it would not have taken if it had sufficient cash flow. Insolvency
 Stock-base insolvency; the value of the firm’s assets is less than the value of the debt.

Solvent firm

Insolvent firm

Debt
Assets

Assets
Equity

Note the negative equity

Debt
Equity
Debt

Insolvency
 Flow-base insolvency occurs when the firms cash flows are insufficient to cover contractually required payments. $
Cash flow shortfall Contractual obligations Firm cash flow
Insolvency

time

Responses to Financial Distress
 Think of the two sides of the balance sheet.
 Asset Restructuring:
 Selling major assets.
 Merging with another firm.
 Reducing capital spending and R&D spending.

 Financial Restructuring:





Issuing new securities.
Negotiating with banks and other creditors.
Exchanging debt for equity.
Filing for bankruptcy.

Is the firm worth more as a going concern?
 If the firm is worth more if it continues then the creditors can gain more by deferring their claims: reorganization.
 If the firm is worth less if continues then the best option for creditors is to liquidate.
 As long as an agreement can be worked out, creditors will optimally choose liquidation or reorganization.

7

Bankruptcy Liquidation
Straight liquidation usually involves:
1. A petition is filed in a federal court. The debtor firm could file a voluntary petition or the creditors could file an involuntary petition against the firm.
2. A trustee-in-bankruptcy is elected by the creditors to take over the assets of the debtor firm. The trustee will attempt to liquidate the firm’s assets.
3. After the assets are sold, after payment of the costs of administration, money is distributed to the creditors.
4. If any money is left over, the shareholders get it.

Bankruptcy Liquidation: Priority of
Claims
The distribution of the proceeds of liquidation occurs according to the following priority:

1. Administration expenses associated with liquidation. 2. Other expenses arising after the filing of an involuntary bankruptcy petition.
3. Wages, salaries and commissions.
4. Municipal tax claims.
5. Rent.
6. Claims resulting from employee injuries.
7. Unsecured creditors.
8. Preferred shareholders.
9. Common shareholders.

Example
 Suppose the B.O. Drug Co. decides to liquidate.
 Assume that the liquidation value is $2.7 million. Bonds worth $1.5 million are secured by a mortgage on the corporate headquarters building, which is sold for $1 million. $200,000 is used to cover administrative costs and other claims—after paying this, $2.5 million is available to pay creditors. The only problem is that the unpaid debt is $4 million.

Example (continued)
Following our list of priorities, all creditors are paid before shareholders, and the mortgage bondholders are first in line. The trustee proposes the following distribution:
Type of Claim

Prior Claim

Cash Received
Under Liquidation

Mortgage Bonds

$1,500,000

$1,500,000

Subordinated
Debentures

$2,500,000

$1,000,000

Common Stock
Total

$10,000,000
$14,000,000

$
0
$2,500,000

Key issues
 Priority in payment
 Secured vs. unsecured
 Senior vs. junior or subordinated

Bankruptcy Reorganization:
A typical sequence:
1. A voluntary petition can be filed by the corporation or an involuntary petition can be filed by creditors.
2. A federal judge either approves or denies the petition.
3. In most cases the corporation continues to run the business. 4. The firm is
Show More

Related Documents: Bankruptcy and Debentures Subordinated Debentures Essay

Essay on Finance: Common Stock

callable at 105 means that a 5 percent call premium will be paid on the face value if the bond is ever called. 3. From an investor's standpoint, a debenture issued by the Acme Aglet Company will appear "riskier" than a share of preferred stock issued by the Acme Aglet Company.---false In the event of liquidation of the firm, holders of debentures have a higher claim on Acme´s assets over preferred shareholders. 4. The participating feature allows preferred shareholders to share in increasing…

Words 929 - Pages 4

Essay about Pool of Term

payments occur at the beginning of each period. * Annuity: a series of equal dollar payments made for a specified number of years. * Any unsecured long-term debt: Debentures are unsecured long-term debt. For issuing firm, debentures provide the benefit of not tying up property as collateral. For bondholders, debentures are more risky than secured bonds and provide a higher yield than secured bonds. * Bond ratings: Reflect the future risk potential of the bonds. Three prominent bond rating…

Words 1836 - Pages 8

Debtholders And Equityholders Essay

The University of Chicago The University of Chicago Law School Debtholders and Equityholders Author(s): Hideki Kanda Source: The Journal of Legal Studies, Vol. 21, No. 2 (Jun., 1992), pp. 431-448 Published by: The University of Chicago Press for The University of Chicago Law School Stable URL: http://www.jstor.org/stable/724489 . Accessed: 27/10/2014 00:24 Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms…

Words 7476 - Pages 30

Corporation (Fisch) Outline Penn Law Essay

Table of Contents I.) INTRODUCTORY PRINCIPLES 2 A.) Efficiency and Other Concepts 2 B.) Agency and Partnership Law 2 II.) INTRODUCTION TO THE CORPORATE FORM 16 A.) Formation and Structure 16 B.) Debt, Equity, and Valuation 22 III.) CONTROL OF CORPORATE DECISIONS 32 A.) The Role of the Shareholder 32 B.) Management Obligations 50 1.) Duty of Care 51 2.) Duty of Loyalty 56 3.) Duty of Fairness: Parent-Subsidiary Relationships 63 4.) Duty of Good Faith 64 5.) Management Obligations…

Words 62789 - Pages 252

Solutions Manual Essay

Solutions Manual FINANCIAL MANAGEMENT Principles and Practice Fifth Edition Timothy J. Gallagher Colorado State University  2009 Freeload Press, Madison Wisconsin (Insert publication data on this page) i Solutions Manual to accompany Financial Management: Principles and Practice 5th Edition by Timothy J. Gallagher This solutions manual provides the answers to all the review questions and end-of-chapter problems in Financial Management: Principles and Practice, by Timothy…

Words 49126 - Pages 197