Executive Summary - PowerPoint PPT Presentation

Loading...

PPT – Executive Summary PowerPoint presentation | free to download - id: c4a3-YTE3N



Loading


The Adobe Flash plugin is needed to view this content

Get the plugin now

View by Category
About This Presentation
Title:

Executive Summary

Description:

This chapter discusses financial distress, private workouts, and bankruptcy. ... Macy's. 5,300. 1992. 31-7. McGraw-Hill Ryerson 2003 McGraw Hill Ryerson Limited ... – PowerPoint PPT presentation

Number of Views:204
Avg rating:3.0/5.0
Slides: 29
Provided by: johns505
Learn more at: http://highered.mcgraw-hill.com
Category:

less

Write a Comment
User Comments (0)
Transcript and Presenter's Notes

Title: Executive Summary


1
(No Transcript)
2
Executive Summary
  • This chapter discusses financial distress,
    private workouts, and bankruptcy.
  • A firm that defaults on a required payment may be
    forced to liquidate its assets. More often, a
    defaulting firm will reorganize.
  • Financial restructuring involves replacing old
    financial claims with new ones and takes place
    with private workouts or legal bankruptcy.

3
Chapter Outline
  • 31.1 What is Financial Distress?
  • 31.2 What Happens in Financial Distress?
  • 31.3 Bankruptcy Liquidation and Reorganization
  • 31.4 Current Issues in Financial Distress
  • 31.5 The Decision to Seek Court Protection The
    Case of Olympia and York
  • 31.6 Summary and Conclusions
  • Appendix 31-A Predicting Corporate Bankruptcy
    The Z-score model

4
31.1 What is Financial Distress?
  • A situation where a firms operating cash flows
    are not sufficient to satisfy current obligations
    and the firm is forced to take corrective action.
  • Financial distress may lead a firm to default on
    a contract, and it may involve financial
    restructuring between the firm, its creditors,
    and its equity investors.
  • Usually the firm is forced to take actions that
    it would not have taken if it had sufficient cash
    flow.

5
Insolvency
  • Stock-base insolvency the value of the firms
    assets is less than the value of the debt.

Debt
6
Insolvency
  • Flow-base insolvency occurs when the firms cash
    flows are insufficient to cover contractually
    required payments.

Firm cash flow
7
The Largest U.S. Bankruptcies
8
31.2 What Happens in Financial Distress?
  • Financial distress does not usually result in the
    firms death.
  • Firms deal with distress by
  • Selling major assets.
  • Merging with another firm.
  • Reducing capital spending and research and
    development.
  • Issuing new securities.
  • Negotiating with banks and other creditors.
  • Exchanging debt for equity.
  • Filing for bankruptcy.

9
What Happens in Financial Distress
Financialdistress
Financialdistress
Reorganize and emerge
Liquidation
Reorganize and emerge
Financialdistress
Merge with another firm
10
Responses to Financial Distress
  • Think of the two sides of the balance sheet.
  • Asset Restructuring
  • Selling major assets.
  • Merging with another firm.
  • Reducing capital spending and RD spending.
  • Financial Restructuring
  • Issuing new securities.
  • Negotiating with banks and other creditors.
  • Exchanging debt for equity.
  • Filing for bankruptcy.

11
31.3 Bankruptcy Liquidation and Reorganization
  • Firms that cannot meet their obligations have two
    choices liquidation or reorganization.
  • Liquidation means termination of the firm as a
    going concern.
  • It involves selling the assets of the firm for
    salvage value.
  • The proceeds, net of transactions costs, are
    distributed to creditors in order of priority.
  • Reorganization is the option of keeping the firm
    a going concern.
  • Reorganization sometimes involves issuing new
    securities to replace old ones.

12
Bankruptcy Liquidation
  • Straight liquidation usually involves
  • A petition is filed in a federal court. The
    debtor firm could file a voluntary petition or
    the creditors could file an involuntary petition
    against the firm.
  • A trustee-in-bankruptcy is elected by the
    creditors to take over the assets of the debtor
    firm. The trustee will attempt to liquidate the
    firms assets.
  • After the assets are sold, after payment of the
    costs of administration, money is distributed to
    the creditors.
  • If any money is left over, the shareholders get
    it.

13
Bankruptcy Liquidation Priority of Claims
  • The distribution of the proceeds of liquidation
    occurs according to the following priority
  • Administration expenses associated with
    liquidation.
  • Other expenses arising after the filing of an
    involuntary bankruptcy petition.
  • Wages, salaries and commissions.
  • Municipal tax claims.
  • Rent.
  • Claims resulting from employee injuries.
  • Unsecured creditors.
  • Preferred shareholders.
  • Common shareholders.

14
Example
  • Suppose the B.O. Drug Co. decides to liquidate.
  • Assume that the liquidation value is 2.7
    million. Bonds worth 1.5 million are secured by
    a mortgage on the corporate headquarters
    building, which is sold for 1 million. 200,000
    is used to cover administrative costs and other
    claimsafter paying this, 2.5 million is
    available to pay creditors. The only problem is
    that the unpaid debt is 4 million.

15
Example (continued)
  • Following our list of priorities, all creditors
    are paid before shareholders, and the mortgage
    bondholders are first in line. The trustee
    proposes the following distribution

16
Bankruptcy Reorganization
  • A typical sequence
  • A voluntary petition can be filed by the
    corporation or an involuntary petition can be
    filed by creditors.
  • A federal judge either approves or denies the
    petition.
  • In most cases the debtor continues to run the
    business.
  • The firm is required to submit a reorganization
    plan.
  • Creditors and shareholders are divided into
    classes.
  • After acceptance by the creditors, the plan is
    confirmed by the court.
  • Payments in cash, property, and securities are
    made to creditors and shareholders.

17
Reorganization Example
  • Suppose the B.O. Drug Co. decides to reorganize
    under the Bankruptcy and Insolvency Act.
  • Assume that the going concern value is 3
    million and its balance sheet is shown.

18
Reorganization Example
  • The firm has proposed the following
    reorganization plan

19
Reorganization Example
  • And a distribution of new securities under a new
    claim with the reorganization plan

20
31.4 Current Issues in Financial Distress
  • Both formal bankruptcy and private workouts
    involve exchanging new financial claims for old
    financial claims.
  • Usually senior debt is replaced with junior debt
    and debt is replaced with equity.
  • When they work, private workouts are better than
    a formal bankruptcy.
  • Complex capital structures and lack of
    information make private workouts less likely.

21
Private Workout or Bankruptcy Which is Best?
  • In Canada, the new Bankruptcy and Insolvency Act
    has added increased costs and time commitments to
    the formal bankruptcy proceedings.
  • Direct negotiations (private workouts) between
    creditors and debtors can be expected to
    increase.
  • Bankruptcy is better for equity investors than
    for creditors because equity investors can
    usually hold out for a better deal in bankruptcy.

22
Prepackaged Bankruptcy
  • Prepackaged Bankruptcy is a combination of a
    private workout and legal bankruptcy.
  • The firm and most of its creditors agree to
    private reorganization outside the formal
    bankruptcy.
  • After the private reorganization is put together
    (prepackaged) the firm files a formal bankruptcy.
  • The main benefit is that it forces holdouts to
    accept a bankruptcy reorganization.
  • Offers many of the advantages of a formal
    bankruptcy, but is more efficient.

23
The Decision to Seek Court Protection The Case
of Olympia and York
  • Olympia and York (OY) was one of the largest
    companies in Canada.
  • On May 14, 1992, OY filed for court protection
    in Canada under the Companies Creditors
    Arrangement Act.
  • The recession of the early 1990s led to a major
    decline in real estate prices and an increase in
    vacancy rates.
  • OY (a highly leveraged company) could not
    service its debt because of a lack of cash flow.

24
The Decision to Seek Court Protection The Case
of Olympia and York (continued)
  • Costs of the OY restructuring include
  • Direct costs of restructuring.
  • Legal fees 5.75 million
  • Accounting fees 2.65 million
  • Costs of financial advisors 8.50 million
  • Indirect costs of restructuring management
    distraction, loss of customers, and loss of
    reputation.
  • Costs of a complicated financial structure
    Conflicts between managers, shareholders, and
    creditors make reaching a private agreement
    difficult.

25
31.6 Summary and Conclusions
  • Financial distress is a situation where a firms
    operating cash flow is not sufficient to cover
    contractual obligations.
  • Financial restructuring can be accomplished with
    a private workout or formal bankruptcy.
  • Corporate bankruptcy involves liquidation or
    reorganization.
  • A hybrid of a private workout and formal
    bankruptcy is prepackaged bankruptcy.

26
Appendix 31-A Predicting Corporate Bankruptcy
The Z-score model
  • Many potential lenders use credit scoring models
    to assess the creditworthiness of prospective
    borrowers.
  • The general idea is to find factors that enable
    the lenders to discriminate between good and bad
    credit risks.
  • Edward Altman has developed a model using
    financial statement ratios and multiple
    discriminant analyses to predict bankruptcy for
    publicly traded manufacturing firms

27
Appendix 31-A Predicting Corporate Bankruptcy
The Z-score model (continued)
  • The resultant model is of the form
  • Z 3.3(EBIT/Total assets) 1.2(Net working
    capital/Total assets) 1.0(Sales/Total assets)
    0.6(Market value of equity/Book value of debt)
    1.4(Accumulated retained earnings/Total assets)
  • where Z is an index of bankruptcy.
  • Bankruptcy would be predicted if Z ? 1.81 and
    nonbankruptcy if Z ? 2.99.

28
Appendix 31-A Predicting Corporate Bankruptcy
The Z-score model (continued)
  • Altman uses a revised model to make it applicable
    for private firms and non-manufacturers.
  • The resulting model is
  • Z 6.56(Net working capital/Total assets)
  • 3.26(Accumulated retained earnings/Total
    assets)
  • 1.05(EBIT/Total assets) 6.72(Book value of
    equity/Total liabilities)
  • where Z ? 1.23 indicates a bankruptcy
    prediction.
  • 1.23 ? Z ? 2.90 indicates a grey area,
  • and Z ? 2.90 indicates no
    bankruptcy.
About PowerShow.com