To do this the dip must estimate both the liquidation

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Unformatted text preview: existing debts are extended. Because reorganization activities are largely in the hands of the debtor in possession (DIP), it is useful to understand the DIP’s responsibilities. The DIP’s first responsibility is the valuation of the firm to determine whether reorganization is appropriate. To do this, the DIP must estimate both the liquidation value of the business and its value as a going concern. If the firm’s value as a going concern is less than its liquidation value, the DIP will recommend liquidation. If the opposite is found to be true, the DIP will recommend reorganization, and a plan of reorganization must be drawn up. The key portion of the reorganization plan generally concerns the firm’s capital structure. Because most firms’ financial difficulties result from high fixed charges, the company’s capital structure is generally recapitalized to reduce these 740 PART 6 Special Topics in Managerial Finance charges. Under recapitalization, debts are generally exchanged for equity or the maturities of existing debts are extended. When recapitalizing the firm, the DIP seeks to build a mix of debt and equity that will allow the firm to meet its debts and provide a reasonable level of earnings for its owners. Once the revised capital structure has been determined, the DIP must establish a plan for exchanging outstanding obligations for new securities. The guiding principle is to observe priorities. Senior claims (those with higher legal priority) must be satisfied before junior claims (those with lower legal priority). To comply with this principle, senior suppliers of capital must receive a claim on new capital equal to their previous claim. The common stockholders are the last to receive any new securities. (It is not unusual for them to receive nothing.) Security holders do not necessarily have to receive the same type of security they held before; often they receive a combination of securities. Once the debtor in possession has determined the new capital structure and distribution of capital, it will submit the reorganization plan and disclosure statement to the court as described. Liquidation in Bankruptcy (Chapter 7) The liquidation of a bankrupt firm usually occurs once the bankruptcy court has determined that reorganization is not feasible. A petition for reorganization must normally be filed by the managers or creditors of the bankrupt firm. If no petition is filed, if a petition is filed and denied, or if the reorganization plan is denied, the firm must be liquidated. Procedures When a firm is adjudged bankrupt, the judge may appoint a trustee to perform the many routine duties required in administering the bankruptcy. The trustee takes charge of the property of the bankrupt firm and protects the interest of its creditors. A meeting of creditors must be held between 20 and 40 days after the bankruptcy judgment. At this meeting, the creditors are made aware of the prospects for the liquidation. The trustee is given the responsibility to liquidate the firm, keep records, examine creditors...
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