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A failed firm that cannot or does not want to arrange

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Unformatted text preview: combination of these strategies. If creditors do not agree to a plan to sustain a firm, they may recommend voluntary liquidation, which bypasses many of the legal requirements and costs of bankruptcy proceedings. LG5 SELF-TEST PROBLEMS Explain bankruptcy legislation and the procedures involved in reorganizing or liquidating a bankrupt firm. A failed firm that cannot or does not want to arrange a voluntary settlement can voluntarily or involuntarily file in federal bankruptcy court for reorganization under Chapter 11 or for liquidation under Chapter 7 of the Bankruptcy Reform Act of 1978. Under Chapter 11, the judge will appoint the debtor in possession, which, with court supervision, develops, if feasible, a reorganization plan. A firm that cannot be reorganized under Chapter 11 of the bankruptcy law or does not petition for reorganization is liquidated under Chapter 7. The responsibility for liquidation is placed in the hands of a court-appointed trustee, whose duties include liquidating assets, distributing the proceeds, and making a final accounting. Liquidation procedures follow a priority of claims for distribution of the proceeds from the sale of assets. LG6 (Solutions in Appendix B) LG3 ST 17–1 Cash acquisition decision Luxe Foods is contemplating acquisition of Valley Canning Company for a cash price of $180,000. Luxe currently has high financial leverage and therefore has a cost of capital of 14%. As a result of acquiring Valley Canning, which is financed entirely with equity, the firm expects its financial leverage to be reduced and its cost of capital therefore to drop to 11%. The acquisition of Valley Canning is expected to increase Luxe’s cash inflows by $20,000 per year for the first 3 years and by $30,000 per year for the following 12 years. a. Determine whether the proposed cash acquisition is desirable. Explain your answer. b. If the firm’s financial leverage would actually remain unchanged as a result of the proposed acquisition, would this alter your recommendation in part a? Support your answer with numerical data. LG3 ST 17–2 Expected EPS—Merger decision At the end of 2003, Lake Industries had 80,000 shares of common stock outstanding and had earnings available for common of $160,000. Butler Company, at the end of 2003, had 10,000 shares of common stock outstanding and had earned $20,000 for common shareholders. Lake’s earnings are expected to grow at an annual rate of 5%, and Butler’s growth rate in earnings should be 10% per year. CHAPTER 17 Mergers, LBOs, Divestitures, and Business Failure 745 a. Calculate earnings per share (EPS) for Lake Industries for each of the next 5 years (2004–2008), assuming that there is no merger. b. Calculate the next 5 years’ (2004–2008) earnings per share (EPS) for Lake if it acquires Butler at a ratio of exchange of 1.1. c. Compare your findings in parts a and b, and explain why the merger looks attractive when viewed over the long run. PROBLEMS LG1 LG3 17–1 Tax effects of acquisition Connors Shoe Company is contemplating the acquisition of Salinas Boots, a firm that has shown...
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