Financial Distress Essay

1489 words - 6 pages

AFM 371 Winter 2008
Chapter 31 - Financial Distress

1 / 14


What Happens in Financial Distress?
Bankruptcy Liquidation and Reorganization
Current Issues in Financial Distress
Two Practice Problems From Chapter 16

2 / 14



as we will see in Chapter 17, financial distress (and its
associated costs) has a potentially large impact on capital
structure decisions by firms
a firm that defaults on a required payment may be forced to
liquidate its assets
however, more often a defaulting firm will restructure
financial restructuring involves replacing old financial claims
with new ones and takes place with either private workouts or
...view middle of the document...

S. Experience
No financial






What Happens in Financial Distress?




and emerge





Merge with
another firm



7 / 14

Bankruptcy Liquidation and Reorganization
in a legal bankruptcy, firms effectively have two options:
liquidation or reorganization
liquidation means termination of the firm as a going concern
involves selling the assets of the firm for salvage value
proceeds are distributed to creditors in order of priority

reorganization is the option of keeping the firm as a going
sometimes involves issuing new securities to replace old ones

liquidation usually involves:
a petition is filed in court (either voluntarily by the firm or the
creditors can file an involuntary petition)
a trustee-in-bankruptcy is elected by the creditors to take over
the assets of the firm and try to liquidate them
after the assets are sold, money is distributed to the creditors
(after administrative expenses are paid)
any remaining money goes to the shareholders
Bankruptcy Liquidation and Reorganization

8 / 14

Priority of Claims in Liquidation



Administrative expenses associated with liquidation
Other expenses arising after the filing of an involuntary
bankruptcy petition but prior to the appointment of a trustee
Wages, salaries, and commissions
Municipal tax claims
Claims from employee injuries not covered by workers’
Unsecured creditors
Preferred shareholders
Common shareholders
note that (i) federal income tax must be paid before any of
the above; (ii) secured creditors receive proceeds from sale of
the securing assets (if the amount is insufficient, they join this
list as unsecured creditors); and (iii) courts have considerable
flexibility to deviate from this list

Bankruptcy Liquidation and Reorganization

9 / 14

Liquidation Example
consider the example on pp. 887-888 in the text
the liquidation value is assumed to be $2.7 million
bonds worth $1.5 million are secured by a mortgage on a
building, which is sold for $1 million
$200,000 is used to cover administrative costs
a total of $2.5 million is available to pay creditors
the unpaid debt is $4 million
following the priority list, the trustee proposes the following
Type of Claim
Mortgage bonds
Subordinated debentures
Common stock

Bankruptcy Liquidation and Reorganization

Prior Claim

Cash Received
Under Liquidation
10 / 14

Bankruptcy Reorganization: A Typical Sequence

A voluntary petition can be filed in court by the firm or an
involuntary petition can be filed by the creditors


A federal judge either approves or denies the petition


In most cases, the debtor continues to run...

Other Essays Like Financial Distress

Capital Structure (D/E) Differs Substantially From One Company/Industry To Another. Can Theories Of Capital Structure Shed Light On This?

1052 words - 5 pages financial distress and bankruptcy. With additions to debt at relatively low levels of debt, the tax advantages increase faster than expected financial distress costs, therefore, the value of the firm increases. However, if the debt level continues to increase beyond the optimal debt level, then the increasing marginal expected cost of bankruptcy more than overcomes the marginal debt related tax advantage and the value of the firm declines. (Claggett

Aspen Case Study

698 words - 3 pages position because the company will benefit if £ appreciate. Per contra, the Belgian Francs is in SHORT position: the company will loose money if Belgian Francs appreciate. 3) What goal would you recommend for the firm’s currency risk management program? Why? Based on your goal, what types of exposure should Aspen be measuring? The company has to hedge its cash flow when it is in financial distress. When looking at their account figures, we

Theoretical Perspectives on Understanding Mental Distress

3324 words - 14 pages given a diagnosis of schizophrenia, if focusing totally on the bio medical model. Tyrer and Steinberg (1998) make reference to the fact that psychodynamic treatment can be time consuming and draining on financial resources. The second theoretical perspective which has influenced my view on interpreting mental distress is John Bowlby’s attachment theory, in my practice within the young adult mental health and the ADHD service I have become

Info System Technologies

1112 words - 5 pages a large loss of both customers and engineering talent in the event of financial distress, managers believe that if IST borrows the $500, the present value of financial distress costs will exceed any tax benefits by 20 million. At the same time, because investors believe that managers know the correct share price, IST faces a lemons problem if it attempts to raise the $500 million by issuing equity. Answer the following questions with

Valuation of Bonds

2275 words - 10 pages evaluation due to creative accounting. It should be noted that results from studies identified in this paper are under the assumption that company information was presented in a fair and honest context. Nonetheless, creative accounting is an issue that researchers should address more and more due to the increase of companies to hide weak performance or financial distress. Alwathainani (2009) focused on the level of consistency with a firms’ past

Us Airways Group

3354 words - 14 pages never curtail the significance of terminal valuation of the company. It is important noting that determination of capability of US Airways Inc to handle corporate distress is dependent on the terminal value determined for the company. The aviation industry is consistent of a number of risks and uncertainties that materially affects any projected financial performance. US Airways: Acquisition or Takeover US Airways Inc is a highly potent

Financial Report Sample

1529 words - 7 pages its marginal corporate tax rate is 35%. Also, you model the firm's PV of financial distress as a function of its debt ratio (D/V) according to the relation: PV of financial distress = 800,000 × (D/V)2. What is the firm's levered value if it issues $200,000 of perpetual debt to buy back stock? A. B. C. D. $820,000. $869,555. $920,000. $350,000. 10. Which of the following entities likely has the highest cost of financial distress? A

Reporting Practices and Ethics Paper

1001 words - 5 pages facility, it is most likely the financial distress can be lowered. The problem is that in general with financial accounting, that there is not an accepted, reliable and systematic system for measuring and routine reporting areas of financial risk in the organizations. But, the development of demanding procedures for financial risk management needs to be a key process for management accounting research (Kumarasinghe, 2010). In conclusion all of

Usec Inc. Case

965 words - 4 pages Perfect Financial Market Assumption 1. Frictionless market – operational efficiency– no transaction costs, taxes, government intervention, agency costs, or costs of financial distress. 2. Equal access to market prices – informational efficiency (IE) – no single party can influence prices. 3. Rational investors – IE – investors price assets with a dispassionate eye toward expected returns and risks. 4. Equal access to costless

Financial Statments Paper

813 words - 4 pages allows them to evaluate the financial health of the company and evaluate the company’s ability to meet its obligations currently and after considering new debt. A creditor will also use the balance and sometimes the income statement to ensure that the company is compliance with covenants of the debt agreement. Debt covenants give the creditors a legal basis to call the debt due if the company goes into financial distress. Which financial

Strategic and Financial Planning

1169 words - 5 pages also in the future competitive environment. What future will look like? To try to anticipate this, managers can use scenario planning techniques to plan for different possible futures (Hill, C.W.L. and Jones, G.R. 2009). Lack of effective financial planning demonstrates financial distress and failure for the firm. Financial planning establishes course of action for change and growth in firm (Ross, A.S. et al. 2011). Introduction: Strategic

Related Papers

Financial Distress Essay

1489 words - 6 pages Financial Distress Costs: A common example of a cost of financial distress is bankruptcy costs. These direct costs include auditors' fees, legal fees, management fees and other payments. Cost of financial distress can occur even if bankruptcy is avoided (indirect costs): Financial distress in companies can lead to problems that can reduce the efficiency of management. As maximizing firm value and maximizing shareholder value cease to be

Financial Distress Performance In Company Essay

1795 words - 8 pages 1.0 TABLE OF CONTENT CONTENT PAGES 2.0 THE ABSTRACT 2 3.0 THE INTRODUCTION 3 4.0 THE DISCUSSION 4 5.0 THE CONCLUSION 5 6.0 RECOMMENDATION 6 7.0 REFERENCES 8 2.0 THE ABSTRACTThis study was aim to assess the performance of Malaysian companies after suffering from a financial distress condition. Many companies post abnormal profits during their first few years, but the profits are not sustainable. So they face another

Accounting Essay

976 words - 4 pages Introduction of the article From 2013, the global coal price has decreased significantly caused by the declining coal consumption and many researches indicate that the sharp decline in coal price is structural rather than cyclical which means, unlike what the government and the coal fraternity said, demand may not rebound. Under such circumstance, the Australian coal producer, Peabody Energy is under a huge financial distress risk. In four

Capital Structure Essay

1212 words - 5 pages tries to explain how companies choose their capital structure by balancing the benefits of interest rate tax shields and the costs of financial distress. As the existence of taxation and bankruptcy costs imply that the market is not perfect, Modigliani-Millers Proposition I doesn’t hold any more and there is an optimal capital structure for each company that maximizes firm value. The tax advantage of debt arises as interest expenses are tax