At the time it defaulted on its interest payments and filed for bankruptcy, the
ID: 2625124 • Letter: A
Question
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 $370,000, while the current assets were sold for another $310,000. Thus, the total proceeds from the liquidation sale were $680,000. The trustee's costs amounted to $70,000; no single worker was due more than $2,000 in wages; 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.
a. How much will McDaniel's shareholders receive from the liquidation.
b. How much will the mortgage bondholders receive?
c. Who are other priority claimants in addition to bondholders? How much will they receive from the liquidation?
d. Who are the remaining general creditors? How much will each receive from distribution before surodination adjustments? What is the effect of adjusting for subordination?
Explanation / Answer
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
Accounts payable $ 50,000
Notes payable 180,000
Second mortgage bonds 100,000
Debentures 200,000
Subordinated debentures 100,000
Total $630,000
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 Amount Received
Accounts payable $ 6,350
Notes payable 22,860
Second mortgage bonds 12,700 (plus $100,000)
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 $180,000 - $22,860 = $157,140 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
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