Question

Reorganization

The Verbrugge Publishing Company's 2016 balance sheet and income statement are as follows (in millions of dollars).

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

Income
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 $2.90 preferred with a par value of $36.00 plus one 8% subordinated income debenture with a par value of $76.5. 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:

Current assets	$		Current liabilities	$
Net fixed assets	$		Advance payments	$
Goodwill	$		Reserves	$
			Subordinated debentures	$
			$2.9 preferred stock, $36 par value (1,200,000 shares)	$
			Common stock, $1.50 par value (6,000,000 shares)	$
			Retained earnings	$
Total assets	$		Total claims	$

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:

Net sales	$
Operating expense	$
Net operating income	$
Other income	$
EBIT	$
Interest expense	$
EBT	$
Taxes (50%)	$
Net income	$
Dividends on $2.90 preferred	$
Income available to common stockholders	$

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.

The required pre-tax earnings before recapitalization	$  million
The required pre-tax earnings after recapitalization	$  million

How is the debt ratio affected by the reorganization? Round your answers to two decimal places.

The debt ratio before reorganization	%
The debt ratio after reorganization	%

Answer 1

1. The projected balance sheet (in millions of dollars) follows:

Current Assets	$159	Current Liabilities	$42
Net Fixed Assets	$153	Advance payments	$78
Goodwill	$15	reserves	$6
		$2.9 Preferred Stock (Par value $36, 1,200,000)	$43.2
		8% Prefeered Stock (Par value $76.5, 1,200,000)	$91.8
		Common stock	$9
		Retained earnings	$57
Total Assets	$327	Total claims	$327

Explanation:

Calculation of the par value of subordinated debentures after reorganization:

= 1,200,000 * $76.5 = $91,800,000

Preferred share par value = 1,200,000 * $36 = $43,200,000

2. Reorganization also affects the amount of preferred dividend as well as the interest expense on the subordinated debentures. So the interest expense is 8% of the $91.80 subordinated debentures ( 91.80 * 0.08 = $7.3 million). The preferred dividend will be 1.2 million shares times the $2.9 preferred ( 1.2 * $2.9 = $3.48 ROUNDED $$3.5)

The projected income statement (in millions of dollars) follows:

Net Sales	$540
Operating expense	-$516
Net Operating Income	$24
Other Income	$3
EBIT	$27
Interest on 8% Debenture	-$7.3
EBT	$19.7
Taxes (50%)	$9.9
Net Income	$9.9
Dividends on $2.90 Stock	$3.5
Income available to common stockholders	$6.4

3. Required pre-tax earnings before and after the recapitalization:

The required pre-tax earnings before recapitalization	$15.6 million
The required pre-tax earnings after recapitalization	$14.2 million

Explanation:

required pre-tax earnings before recapitalization = 7.2 million + 0.6 million / 1- 0.50

= 7.8 / .50 = $15.6 million

required pre-tax earnings after recapitalization = 7.2 million + (3.5 million / 1- 0.50)

= $7.2 million + $7 million = $14.2 million

4. Debt ratio:

The debt ratio before reorganization	35.7%
The debt ratio after reorganization	64.8%

Explanation:

Debt ratio is calculated by taking all liabilties and dividing them by Total assets

The debt ratio before reorganization = $42 million + $78 million/ $336 million = 35.7%

The debt ratio after reorganization = $42 million + $78 million + $91.8 million / $327 million = 64.8%