Because on a balance sheet the firms assets equal the

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Unformatted text preview: firm’s management should attempt to prolong the growth stage through research, new products, and mergers. Once the firm has matured and has begun to decline, it should seek to be acquired by 9. Because on a balance sheet the firm’s assets equal the sum of its liabilities and stockholders’ equity, the only way a firm that has more liabilities than assets can balance its balance sheet is to have a negative stockholders’ equity. 10. The success of some firms runs countercyclical to economic activity, and other firms are unaffected by economic activity. For example, the auto repair business is likely to grow during a recession, because people are less likely to buy new cars and therefore need more repairs on their unwarranted older cars. The sales of boats and other luxury items may decline during a recession, whereas sales of staple items such as electricity are likely to be unaffected. In terms of beta—the measure of nondiversifiable risk developed in Chapter 5—a negative-beta stock would be associated with a firm whose behavior is generally countercyclical to economic activity. 736 PART 6 Special Topics in Managerial Finance another firm or liquidate before it fails. Effective management planning should help the firm to postpone decline and ultimate failure. Voluntary Settlements voluntary settlement An arrangement between a technically insolvent or bankrupt firm and its creditors enabling it to bypass many of the costs involved in legal bankruptcy proceedings. When a firm becomes technically insolvent or bankrupt, it may arrange with its creditors a voluntary settlement, which enables it to bypass many of the costs involved in legal bankruptcy proceedings. The settlement is normally initiated by the debtor firm, because such an arrangement may enable it to continue to exist or to be liquidated in a manner that gives the owners the greatest chance of recovering part of their investment. The debtor arranges a meeting between itself and all its creditors. At the meeting, a committee of creditors is selected to analyze the debtor’s situation and recommend a plan of action. The recommendations of the committee are discussed with both the debtor and the creditors, and a plan for sustaining or liquidating the firm is drawn up. Voluntary Settlement to Sustain the Firm extension An arrangement whereby the firm’s creditors receive payment in full, although not immediately. composition A pro rata cash settlement of creditor claims by the debtor firm; a uniform percentage of each dollar owed is paid. creditor control An arrangement in which the creditor committee replaces the firm’s operating management and operates the firm until all claims have been settled. Normally, the rationale for sustaining a firm is that it is reasonable to believe that the firm’s recovery is feasible. By sustaining the firm, the creditor can continue to receive business from it. A number of strategies are commonly used. An extension is an arrangement whereby the firm’s creditors receive payment in full, although not immediately. Normally, when...
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