Question

Problem 24-03
Liquidation

At the time it defaulted on its interest payments and filed for bankruptcy, the McDaniel Mining Company had the following balance sheet shown below (in thousands of dollars). The court, after trying unsuccessfully to reorganize the firm, decided that the only recourse was liquidation under Chapter 7. Sale of the fixed assets, which were pledged as collateral to the mortgage bondholders, brought in $310,000, while the current assets were sold for another $320,000. Thus, the total proceeds from the liquidation sale were $630,000. The trustee's costs amounted to $40,000; no single worker was due more than the maximum allowable wages per worker; and there were no unfunded pension plan liabilities.

Current assets	$  400		Account payable	$   50
Net fixed assets	600		Accrued taxes	40
			Accrued wages	30
			Notes payable	180
			Total current liabilities	$  300
			First-mortgage bonds*	300
			Second-mortgage bonds*	200
			Debentures	200
			Subordinated debentures**	100
			Common stock	50
			Retained earnings	-150
Total assets	$1,000		Total claims	$1,000
Notes: *All fixed assets are pledged as collateral to the mortgage bonds. **Subordinated to notes payable only.

1. How much will McDaniel's shareholders receive from the liquidation? Round your answer to the nearest dollar.
   $
   
2. How much will the mortgage bondholders receive? Round your answer to the nearest dollar.
   $
   
3. How much will other priority claimants receive from the liquidation? Round your answers to the nearest dollar. Do not round intermediate calculations.

   Claimant	Amount
   Trustee's expenses	$
   Workers' wages due	$
   Governments' taxes due	$
   Total	$

   
   
4. How much will the remaining general creditors receive from the distribution before subordination adjustment? Round your answers to the nearest dollar. Do not round intermediate calculations.

   Account	Amount Received
   Accounts payable	$
   Notes payable	$
   Second mortgage bonds	$
   Debentures	$
   Subordinated debentures	$
   Total	$

   
   What is the effect of adjusting for subordination? Round your answers to the nearest dollar. Do not round intermediate calculations.

   Account	Amount Received after subordination adjustment
   Notes payable	$
   Subordinated debentures	$

Answer 1

(a).Creditor claims total $1,100,000 while the trustee has an additional $50,000 in claims, yet the liquidation produced only $600,000 in proceeds. Since the proceeds are insufficient to satisfy the creditor and trustee claims, the shareholders receive nothing.

(b).The mortgage bondholders have priority claim against the proceeds from the sale of pledged property. Thus, the $400,000 from the fixed assets must first be distributed to the first and second mortgage bondholders. The first mortgage holders receive their full claim of $300,000, while the second mortgage holders receive the remaining $100,000. This constitutes the total $400,000, so none of the proceeds from the sale of pledged assets are available for distribution to general creditors. Additionally, the second mortgage holders have $100,000 in unsatisfied claims which become general creditor claims.

(c).The priority claimants are the mortgage bondholders, trustee, workers, and government. The remaining claimants are general creditors. There is $200,000 available after the $400,000 distribution to the mortgage bondholders. This is distributed to the remaining priority claimants as follows:

Claimant	Amount($)
Trustee's expenses	$ 50,000
Workers' wages due	$ 30,000
Governments' taxes due	$ 40,000
Total	$120,000

(d).Of the total $600,000 received from the liquidation, $520,000 has been distributed to priority claimants. This leaves $80,000 to distribute to the general creditors. But the general creditor claims total $630,000:

Account		Claim amount
Accounts payable	$	50,000
Notes payable	$	1,80,000
Second mortgage bonds	$	1,00,000
Debentures	$	2,00,000
Subordinated debentures	$	1,00,000
Total	$	6,30,000

Note that the second mortgage holders' unsatisfied claim of $100,000 is included. Each claimant, before subordination adjustment, would receive $80,000/$630,000 = 0.1270 of his or her claim. Therefore, the general creditors would receive:

Account		Received amount
Accounts payable	$	6,350
Notes payable	$	22,860
Second mortgage bonds	$	12,700
Debentures	$	25,400
Subordinated debentures	$	12,700
Total	$	80,000

Finally, the subordination adjustment must be made.

The subordinated debentures are subordinate to notes payable.

Therefore, the subordinate debenture holders must relinquish all claims until the note payable holders are fully satisfied.

Since the note payable holders are $157,140(i.e. $180,000 - $22,860) short of being fully satisfied, the full $12,700 initially allocated to the subordinated debenture holders must be relinquished to the notes payable holders resulting