Question

Problem 24-01 Liquidation Southwestern Wear Inc. has the following balance sheet: Current assets $375,000 $1,875,000 1,875,000 Accounts payable Notes payable Fixed assets 750,000 Subordinated debentures 750,000 Total debt $1,875,000 Common equity 1,875,000 Total assets $3,750,000 Total liabilities and equity $3,750,000 The trustee's costs total $274,250, and the firm has no accrued taxes or wages. Southwestern has no unfunded pension liabilities. The debentures are subordinated only to the notes payable. If the firm goes bankrupt and liquidates, how much will each class of investors receive if a total of $3.5 million is received from sale of the assets? Distribution of proceeds on liquidation: 1. Proceeds from sale of assets 2. First mortgage, paid from sale of assets 3. Fees and expenses of administration of bankruptcy 4. Wages due workers earned within 3 months prior to filing of bankruptcy petition 5. Taxes 6. Unfunded pension liabilities 7. Available to general creditors Distribution to general creditors:

Answer 1

Solution: 1. Proceeds from sale of assets = $ 3,750,000 (it is given that a total of $3.5 million is received from sale of assets. 2. First Mortgage, paid from sale of assets = $ 0 (no mortgage on Current Assets and Fixed Assets). 3. Fees and expenses of administration of bankruptcy = $ 274,250 (it is given that trustee's total costs are $ 274,250). 4. Wages due workers earned within 3 months prior to filing of bankruptcy petition = $0 (it is given that the firm has no accrued taxes or wages). 5. Taxes = $ 0 (it is given that the firm has no accrued taxes or wages). 6. Unfunded pension liabilities = $ 0 (it is given that Southwestern has no unfunded pension liabilities). 7. Available to general creditors = $ 3,750,000 - $ 274,250 = $ 3,475,750. Distribution to general creditors: Percentage of Original Claims After Subordination Application of 100% Claims of Claim General Adjustment (3) (1) Distribution Creditors Received (2) (4) Notes $ 750,000 $ 750,000 $ 750,000 100% payable Accounts payable $ 375,000 $ 375,000 $ 375,000 100% Subordinated $ 750,000 $ 750,000 $ 750,000 100% debentures $ 1,875,000 $ 1,875,000 $ 1,875,000 Total Since total amount available to general creditors is more than Claims of general creditors, 100% of distribution is possible. The remaining $ 3,475,750 - $ 1,875,000 = $ 1,600,750 will go to the common stock holders. The common stockholders will receive $1,600,750/$1,875,000 = 85.37% of the amount of equity.