In: Finance
Reorganization The Verbrugge Publishing Company's 2016 balance sheet and income statement are as follows (in millions of dollars).
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 $2.70 preferred with a par value of $35.50 plus one 9% subordinated income debenture with a par value of $77. 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:
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:
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.
How is the debt ratio affected by the reorganization? Round your answers to two decimal places.
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Solution :-
a) Projected Balance sheet after reorganization ( amounts in millions )
Assets |
Amount |
Liabilities |
Amount |
Current assets (168-9) |
159 |
Current liabilities |
42 |
Net fixed assets |
153 |
Advance payables |
78 |
Goodwill |
15 |
Reserves |
6 |
9% Subordinated debentures |
92.40 |
||
$2.7 preferred stock |
42.60 |
||
Common stock, $1.50 par value (6,000,000 shares) |
9 |
||
Retained earnings |
57 |
||
Total assets |
327 |
Total claims |
327 |
Working notes:-
1) The preferred shares of $10.50 valued $9 million will retire with cash. Hence , current asset will decrease by $9 million.
2)One 9% subordinated debenture will be given to one preferred share holder .The par value of sub ordinate debenture is $77.
i) The par value of sub ordinate debenture after reorganization is
Value of subordinate debenture=(Number of preferred shares)× (Par value of subordinate debenture)
=1,200.000×$77
=$92.40 million
ii) Calculation of par value of preferred stock after reorganization
Value of preferred stock
=(Number of preferred stock )×(Par value of preferred stock)
=1,200.000×$35.50
=$42.60 million
b) Projected income statement
Particulars |
Amount |
Net Sales |
540.00 |
(-) Operating expenses |
516.00 |
Net operating income |
24.00 |
Other income |
3.00 |
EBIT |
27.00 |
Interest expense on 9% subordinate debenture ($92.40million×9%) |
8.316 |
EBT |
18.684 |
Taxes (50%) |
9.342 |
Net income |
9.342 |
Dividends on $2.70 preferred |
3.24 |
Income available to common stockholders |
6.102 |
Note:- In the above statement we have adjusted interest expenses and preference dividend.
c)
i) Calculation of required pre-tax earnings before recapitalization
Required pre-tax earnings ={(dividend for $6 preferred shareholder)/(1-tax rate)} +{(dividend for $10.50 preferred shareholder)/(1-tax rate)}
=($7.20million/0.50)+($0.63million/0.50)
=$14.40 mil+$1.26 mil
=$15.66 million
ii) Calculation of required pre-tax earnings after recapitalization
Required pre-tax earnings =Interest on 9% subordinate debentures+{(dividend for $2.70 preferred shareholder)/(1-tax rate)}
=$8.316+(3.24/0.50)
=14.796 million
d) Calculation of Debt ratio before recapitalization
Debt ratio=All liabilities/Total assets
=(current liablities+Advance payments)/Total assets
=(42+78)/336
=0.357 ie 35.70%
Calculation of Debt ratio after recapitalization
Debt ratio=All liablities/Total assets
= (current liablities+Advance payments +debenture)/Total asset
=(42+78+92.40)/327
=0.6495 ie 64.95%
Change in debt ratio= Debt ratio after recapitalization- Debt ratio before recapitalization
=64.95%-35.70%
=29.25%