Question

The Verbrugge Publishing Company's 2018 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 Statement
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 $3.00 preferred with a par value of $36.50 plus one 7% subordinated income debenture with a par value of $76. The $10.50 preferred issue will be retired with cash.

1. 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 $1.23 million should be entered as 1.23, not 1,230,000. 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	$
   			$3 preferred stock, $36.50 par value (1,200,000 shares)	$
   			Common stock, $1.50 par value (6,000,000 shares)	$
   			Retained earnings	$
   Total assets	$		Total claims	$

2. 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 $1.23 million should be entered as 1.23, not 1,230,000. 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 $3.00 preferred	$
   Income available to common stockholders	$

3. 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 $1.23 million should be entered as 1.23, not 1,230,000. Round your answers to two decimal places.

   The required pre-tax earnings before recapitalization: $    million

   The required pre-tax earnings after recapitalization: $    million

4. 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:   %

   If you were a holder of Verbrugge's common stock, would you vote in favor of the reorganization? Why or why not?

   -Select-YesNoItem 28 , because (1) earnings to shareholders are -Select-increaseddecreasedItem 29 , (2) earnings required to cover fixed charges (including preferred dividends) are -Select-increaseddecreasedItem 30 , and (3) income debentures are -Select-lessmoreItem 31 risky to the shareholders than preferred stock.

Answer 1

a. Current assets (Cash) balance decreases by $9 million as it will be used to retire the preferred stock. Hence the new cash balance will be $168 million- $9million =$159 million. Also, the preferred stock component will no longer be present.

The exchanged $6 preferred is listed at par value of $36.50. Multiplying 1.2 million shares by 36.50 gets us $43.8 million as new value of preferred shares.

For subordinate debenture, we take $76 and multiply it by 1.2 million shares to get $91.20 million.

Hence the final balance sheet is,

Current assets	$ 159		Current liabilities	$ 42
Net fixed assets	$ 153		Advance payments	$ 78
Goodwill	$ 15		Reserves	$ 6
			Subordinated debentures	$ 91.2
			$3 preferred stock, $36.50 par value (1,200,000 shares)	$ 43.8
			Common stock, $1.50 par value (6,000,000 shares)	$ 9
			Retained earnings	$ 57
Total assets	$ 327		Total claims	$ 327

b. Reorganization affects:

1. Preferred Dividend: 1.2 million shares*$3 = $3.6 million

2. Interest expense on 7% subordinated debenture = 91.2*0.07=$6.38 million

Hence, the final income statement is:

Net sales	$ 540
Operating expense	$ 516
Net operating income	$ 24
Other income	$ 3
EBIT	$ 27
Interest expense	$ 6.38
EBT	$ 20.62
Taxes (50%)	$ 10.31
Net income	$ 10.31
Dividends on $3.00 preferred	$ 3.6
Income available to common stockholders	$ 6.71

c. Required earnings:

Before Recapitalization

Dividend on $6 preferred	7.2
Dividend on $10.5 preferred	0.6
Total	7.8
Tax (50%)	50%
Pre-tax earning needed	15.6

After Recapitalization

Dividend prior to taxes	3.6
Tax rate	50%
Pre-tax dividend earning	7.2
Interest on debenture	6.38
Pre-tax earning needed	13.58

d.

Before Reorganization

Current liabilities	42
Advance Payments	78
Total Liabilities	120
Total Assets	336
Debt Ratio	35.71%

After Reorganization:

Current liabilities	42
Advance Payments	78
Subordinated Debenture	91.2
Total Liabilities	211.20
Total Assets	327
Debt Ratio	65%