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mini-case-ch24 - Chapter 24 Bankruptcy Reorganization and...

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Chapter 24 Bankruptcy, Reorganization, and Liquidation MINI CASE Kimberly MacKenzie, president of Kim's Clothes Inc., a medium-sized manufacturer of women's casual clothing, is worried. Her firm has been selling clothes to Russ Brothers department store for more than ten years, and she has never experienced any problems in collecting payment for the merchandise sold. Currently, Russ Brothers owes Kim's Clothes $65,000 for spring sportswear that was delivered to the store just two weeks ago. Kim's concern was brought about by an article that appeared in yesterday's Wall Street Journal that indicated that Russ Brothers was having serious financial problems. Further, the article stated that Russ Brothers' management was considering filing for reorganization, or even liquidation, with a federal bankruptcy court. Kim's immediate concern was whether or not her firm would collect its receivables if Russ Brothers went bankrupt. In pondering the situation, Kim also realized that she knew nothing about the process that firms go through when they encounter severe financial distress. To learn more about bankruptcy, reorganization, and liquidation, Kim asked Ron Mitchell, the firm's chief financial officer, to prepare a briefing on the subject for the entire board of directors. In turn, Ron asked you, a newly hired financial analyst, to do the groundwork for the briefing by answering the following questions: a. 1. What are the major causes of business failure? Answer: The major causes of business failure consist of economic factors, such as industry weakness and poor location, and financial factors, such as too much debt and insufficient capital. However, most business failures occur because a number of factors combine to make the business unsustainable. a. 2. Do business failures occur evenly over time? Answer: A fairly large number of businesses fail each year, but the number in any one year has never been a large percentage of the total business population. The failure rate of businesses, however, has tended to fluctuate with the state of the economy. Mini Case: 24 - 1
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a. 3. Which size of firm, large or small, is more prone to business failure? Why? Answer: Bankruptcy is more frequent among smaller firms. While bankruptcy does occur in large firms, they tend to get more help from external sources to avoid it, given their greater impact on the economy and, in the case of large financial institutions, the financial world. The federal government's bailouts of Chrysler and Lockheed are good examples of this external assistance. b. What key issues must managers face in the financial distress process? Answer: As a manager begins to face financial distress, he or she must begin to consider the following key issues: Is this a temporary cash flow problem (technical insolvency), or is it a permanent problem caused by asset values having fallen below debt obligations (insolvency in bankruptcy)?
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