Problem #2 (Reorganization Plan) The Veteran Publishing Company’s 2012 balance s
ID: 2426650 • Letter: P
Question
Problem #2 (Reorganization Plan)
The Veteran Publishing Company’s 2012 balance sheet and income statement are as follows (in millions of dollars). Veteran 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 $2.40 preferred with a par value of $37.50 plus one 8% subordinated income debenture with a par value of $75. The $10.50 preferred issue will be retired with cash.
a.)Construct a pro forma balance sheet assuming that reorganization takes place. Show the new preferred stock at is par value.
b.)Construct the pro forma income statement. What is the income available to common shareholders in the proposed recapitalization?
c.)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?
d.)How is the debt ratio affected by the reorganization? If you were a holder of Veteran’s common stock, would you vote in favor of the reorganization?
Balance Sheet
Current assets
$168
Current liabilities
$42
Net fixed assets
153
Advance payments
78
Goodwill
15
Reserves
6
$6 pref. stock, $112.50 par (1,200,000 shares)
135
$10.50 pref 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 Statement
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
The pro forma balance sheet follows (in millions of dollars):
Current assets
$159a
Current liabilities
$42
Net fixed assets
$153
Advance payments
$78
Good will
$15
Reserves
$6
Subordinated debentures
$90b
$2.40 preferred stock, $37.50 par value, (1,200,000 shares)
$45c
Common stock, $1.50 par value (6,000,000 shares)
$9
Retained earnings
$57
Total assets
$327
Total claims
$327
Current assets
$168
Current liabilities
$42
Net fixed assets
153
Advance payments
78
Goodwill
15
Reserves
6
$6 pref. stock, $112.50 par (1,200,000 shares)
135
$10.50 pref 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
Explanation / Answer
Answer a Balance Sheet after reorganisation ASSETS In $ Million LIABILITIES In $ Million Current assets 159 Current liabilities 42 Net fixed assets 153 Advance payments 78 8% Debentures,$75 par 90 Goodwill 15 Reserves 6 $2.4 pref. stock, $37.50 par (1,200,000 shares) 45 Common stock, $1.50 par value (6,000,000 shares) 9 Retained earnings 57 Total assets 327 Total claims 327 Answer b Income available to Common shareholders In $ Million Net sales 540 Operating expense 516 Net operating income 24 Other income 3 Interest on 8% Debenture 7.2 EBT 19.8 Taxes (50%) 9.9 Net income 9.9 Dividends on $2.4 preferred 2.88 Income available to common stockholders 7.02 Answer c Required to pre tax earning to meet debenture interest and pref dividend before & after recapitalisation Particulars Before recapitalisation after recapitalisation Debenture Interest 0 7.2 $6 Pref.stock dividend 14.4 0 $10.50 Pref.stock dividend 1.2 0 $2.4 Pref.stock dividend 0 5.76 Total 15.6 12.96 Note : Tax adjustment is only applicable for Pref.dividend as they are paid out of earning remaining post tax. Answer d Debt ratio before recapitalisation = Debt / Equity = 0 / 153 = 0 Debt ratio after recapitalisation = Debt / Equity = 90 / 54 = 1.67 Debt ratio will shoot from 0 to 1.67 after recapitalisation. After reorganisation, the earnings available to common stock holders would rise from $5.7 million to $7.02 million. Hence be Veteran's common stock holder , I would vote in favour of reorganisation
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