5. Tundra Tots is being liquidated under Chapter 7 of the Bankruptcy Act. Its cu
ID: 2417449 • Letter: 5
Question
5. Tundra Tots is being liquidated under Chapter 7 of the Bankruptcy Act. Its current balance sheet is shown below. Fixed assets are sold for $25,000,000 and current assets are sold for $18,000,000. All fixed assets are pledged as collateral for all mortgage bonds. Subordinated debentures are subordinate only to notes payable. Trustee costs are $500,000. No employee is owed over $2,000.
a. How much will SHs receive?
b. How much will mortgage bondholders receive?
c. How much will priority creditors receive?
d. Identify the remaining general creditors. How much will each receive before subordination adjustment?
e. How much will each of the general creditors receive after subordination adjustment?
Sale of current assets 18,000,000 Sale of fixed assets 25,000,000 Trustee costs 500,000 Before Before Default Balance Sheet Default Current Assets 75,000,000 Accounts payable 15,000,000 Net fixed assets 50,000,000 Accrued taxes 10,000 Accrued wages 550,000 Notes payable 3,800,000 Total current liabilities 19,360,000 First-mortgage bonds 18,000,000 Second-mortgage bonds 20,000,000 Debentures 45,000,000 Subordinated debentures 14,000,000 Common stock 2,500,000 Retained earnings 6,140,000 Total assets 125,000,000 Total claims 125,000,000Explanation / Answer
Federal bankruptcy laws govern how companies go out of business or recover from crippling debt. A bankrupt company, the "debtor," might use Chapter 11 of the Bankruptcy Code to "reorganize" its business and try to become profitable again. Management continues to run the day-to-day business operations but all significant business decisions must be approved by a bankruptcy court.
Under Chapter 7, the company stops all operations and goes completely out of business. A trustee is appointed to "liquidate" (sell) the company's assets and the money is used to pay off the debt, which may include debts to creditors and investors.
The investors who take the least risk are paid first. For example, secured creditors take less risk because the credit that they extend is usually backed by collateral, such as a mortgage or other assets of the company. They know they will get paid first if the company declares bankruptcy.
Bondholders have a greater potential for recovering their losses than stockholders, because bonds represent the debt of the company and the company has agreed to pay bondholders interest and to return their principal. Stockholders own the company, and take greater risk. They could make more money if the company does well, but they could lose money if the company does poorly. The owners are last in line to be repaid if the company fails. Bankruptcy laws determine the order of payment.
The following is the specified priority ranking of claimants to a company’s assets in the event of bankruptcy:
In a liquidation, the assets are sold off and the available funds are then distributed. If they are distributed in strict accordance with the above priority rankings, then this is in accordance with absolute priority doctrine.
Liquidation Statement
Sale of Fixed Assets
25,000,000
Sale of Current Assets
18,000,000
Less:
Trustee Cost
500,000
Funds Available for Settlement
42,500,000
Debts of Orville are as follows:
Accrued wages
550,000
Accrued Taxes
10,000
First Mortgage Bonds and
Second Mortgage Bonds
25,000,000
Subordinated debentures
14,000,000
Accounts Payable
2,940,000
Total
42,500,000
Liquidation Statement
Sale of Fixed Assets
25,000,000
Sale of Current Assets
18,000,000
Less:
Trustee Cost
500,000
Funds Available for Settlement
42,500,000
Debts of Orville are as follows:
Accrued wages
550,000
Accrued Taxes
10,000
First Mortgage Bonds and
Second Mortgage Bonds
25,000,000
Subordinated debentures
14,000,000
Accounts Payable
2,940,000
Total
42,500,000
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