lecture6 - Page 1 of 3 Week 6 Financial Distress and...

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Financial Distress, Liquidation, and Corporate Restructuring Introduction | Financial Distress, Reorganization, and Liquidation | Corporate Restructuring | Premiums Paid for Target Companies This week, we will discuss financial distress, bankruptcy, and liquidation (chapter 22), as well as mergers and acquisitions. It is important to note the various bankruptcy methods and the priority of claims in the liquidation process. In M & As, the success of the combination is usually determined after several years of coexistence of the combination, when the impact of possible synergies can be assessed. There is a dark side of debt; namely, financial distress and bankruptcy, if interest and principal payments are not made in a timely manner (when due). We learned in the course of Managerial Finance and in Week 1 (when we discussed an optimal capital structure) that, for corporations, the payment of interest is a deductible expense when calculating taxable income. The tax subsidy reduces (lowers) the cost of debt. Because debt costs less than equity (preferred and common stock), firms use more of it. When a firm uses too much debt and cannot make interest and principal payments as required, bankruptcy often results. Although bankruptcy law is federal, it does have state implications. The two chapters of the bankruptcy code that concern us are chapter 7, "Liquidation," and chapter 11, "Reorganization." Although both chapters are important in the world of finance, we are more concerned with chapter 7, as it provides us opportunities to see how the priority of claims works and how debt subordination works. Also of interest is the cram down concept, sometimes
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This note was uploaded on 08/27/2011 for the course FI516 FI516 taught by Professor Fi516 during the Spring '11 term at Keller Graduate School of Management.

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lecture6 - Page 1 of 3 Week 6 Financial Distress and...

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