Question

The Verbrugge Publishing Company's 2016 balance sheet and income statement are as follows (in millions of dollars). Balance Sheet Current assets $168 Current liabilities $42 Net fixed assets 153 Advance payments 78 Goodwill 15 Reserves 6 $6 preferred stock, $112.50 par value (1,200,000 shares) 135 $10.50 preferred stock, no par, callable at $150 (60,000 shares) 9 Common stock, $1.50 par value (6,000,000 shares) 9 Retained earnings 57 Total assets $336 Total claims $336 Income Net sales $540.0 Operating expense 516.0 Net operating income $ 24.0 Other income 3.0 EBT $ 27.0 Taxes (50%) 13.5 Net income $ 13.5 Dividends on $6 preferred 7.2 Dividends on $10.50 preferred 0.6 Income available to common stockholders $ 5.7 Verbrugge and its creditors have agreed upon a voluntary reorganization plan. In this plan, each share of the $6 preferred will be exchanged for one share of $2.30 preferred with a par value of $39.50 plus one 8% subordinated income debenture with a par value of $73. The $10.50 preferred issue will be retired with cash. Construct the projected balance sheet while assuming that reorganization takes place. Show the new preferred stock at its par value. Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places. The projected balance sheet (in millions of dollars) follows: Current assets $ Current liabilities $ Net fixed assets $ Advance payments $ Goodwill $ Reserves $ Subordinated debentures $ $2.3 preferred stock, $39.5 par value (1,200,000 shares) $ Common stock, $1.50 par value (6,000,000 shares) $ Retained earnings $ Total assets $ Total claims $ Construct the projected income statement. What is the income available to common shareholders in the proposed recapitalization? Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places. The projected income statement (in millions of dollars) follows: Net sales $ Operating expense $ Net operating income $ Other income $ EBIT $ Interest expense $ EBT $ Taxes (50%) $ Net income $ Dividends on $2.30 preferred $ Income available to common stockholders $ Required earnings is defined as the amount that is just enough to meet fixed charges (debenture interest and/or preferred dividends). What are the required pre-tax earnings before and after the recapitalization? Enter your answers in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answers to two decimal places. The required pre-tax earnings before recapitalization $ million The required pre-tax earnings after recapitalization $ million How is the debt ratio affected by the reorganization? Round your answers to two decimal places. The debt ratio before reorganization % The debt ratio after reorganization %

Answer 1

a) Projected balance sheet:

Current assets	$159		Current liabilities	$42
Net fixed assets	$153		Advance payments	$78
Goodwill	$15		Reserves	$6
			8% Subordinated debentures,$73 par value (1,200,000 no.s)	$87.6
			$2.3 preferred stock, $39.5 par value (1,200,000 shares)	$47.4
			Common stock, $1.50 par value (6,000,000 shares)	$9
			Retained earnings	$57
Total assets	$327		Total claims	$327

Note: Adjustments made:

1)When 10.5$ preferred stock redeemed with cash the adjustment has been done to current assets and reduced the same amount from current assets ( $168M - $9M)

2)6$ preferred stock redeemed with 8% subordinate debt of value $87.6M (1.2M * 73$) and 2.3$ preferred stock of value $47.4M (1.2M*$2.3)

b) Projected income statement:

Net sales	$540
Operating expense	$516
Net operating income	$24
Other income	$3
EBIT	$27
Interest expense	$7
EBT	$20
Taxes (50%)	$10
Net income	$10
Dividends on $2.30 preferred	$2.76
Income available to common stockholders	$7.24

Note : calculations:

1) Interest on subordinate debt = $87.6M * 0.08 = $7M (rounded off)

2) Divided on preferred dividend = $2.3*1.2M = $2.76M

c) Required earnings:

The required pre-tax earnings before recapitalization ($7.2M + $0.6M)	$ 7.8million
The required pre-tax earnings after recapitalization ($7M * (1-0.5){tax effect})+ $2.76M	$ 6.26million

d) Debt equity ratio:

The debt ratio before reorganization = $120M/$216M = 0.5556 or 55.56%

The debt ratio after reorganization = $207.6M/$119.4M = 1.7387 or 173.87%

Explanation:

debt equity ratio formula is Total liabilities/Total equity

before reorganization total liabilities are sum of current liabilities and advances payment and the remaining sum of total claims is total equity.

after reorganization total liabilities are sum of current liabilities, advance payment and subordinate debt and the remaining sum of total claims will become total equity.