Southwestern Wear Inc. has the following balance sheet:

 

Current assets	$1,875,000	Accounts payable	$ 375,000
Fixed assets	1,875,000	Notes payable	750,000
Â	Â	Subordinated debentures	750,000
Â	Â	Total debt	$1,875,000
Â	Â	Common equity	1,875,000
Total assets	$3,750,000	Total liabilities and equity	$3,750,000

 

The trustee’s costs total $281,250, and the firm has no accrued taxes or wages. 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 $2.5 million is received from sale of the assets?

The Verbrugge Publishing Company’s 2010 balance sheet and income statement are as follows (in millions of dollars):

Balance Sheet	Â	Â	Â
Current assets	$168	Current liabilities	$ 42
Net fixed assets	153	Advance payments	78
Goodwill	15	Reserves	6
Â	Â	$6 preferred stock, $112.50 par value (1,200,000 shares)	135
Â	Â	$10.50 preferred stock, no par, callable at $150 (60,000 shares)	9
Â	Â	Common stock, $1.50 par value (6,000,000 shares)	9
Â	Â	Retained earnings	57
Total assets	$336	Total claims	$336

 

Income Statement	Â
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 $2.40 preferred with a par value of $37.50 plus one 8% subordinated income debenture with a par value of $75. The $10.50 preferred issue will be retired with cash.

a. Construct the projected balance sheet while assuming that reorganization takes place. Show the new preferred stock at its par value.

b. Construct the projected income statement. What is the income available to common shareholders in the proposed recapitalization?

c. 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?

d. How is the debt ratio affected by the reorganization? If you were a holder of Verbrugge’s common stock, would you vote in favor of the reorganization?