FIN-650-Kim—president of Kim’s Clothes Inc., a medium-sized
Subject: Business / Finance
Question
Kim—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 10 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 2 weeks ago.
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Kim’s concern arose from reading an article in yesterday’s Wall Street Journal that indicated Russ Brothers was having serious financial problems. Moreover, the article stated that Russ Brothers’s management was considering filing for reorganization, or even liquidation, with a federal bankruptcy court.
Kim’s immediate concern was whether 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, her 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.
Assume that Russ Brothers did indeed fail, and that it had the following balance
sheet when it was liquidated (in millions of dollars):
Current assets $40.0 Accounts payable $10.0
Net fixed assets 5.0 Notes payable (to banks) 5.0
Accrued wages 0.3
Federal taxes 0.5
State and local taxes 0.2
Current liabilities $16.0
First-mortgage bonds 3.0
Second-mortgage bonds 0.5
Subordinated debenturesa 4.0
Total long-term debt $ 7.5
Preferred stock 1.0
Common stock 13.0
Paid-in capital 2.0
Retained earnings 5.5
Total equity $21.5
Total assets $45.0 Total claims $45.0
The liquidation sale resulted in the following proceeds:
From sale of current assets $14,000,000
From sale of fixed assets 2,500,000
Total receipts $16,500,000
For simplicity, assume there were no trustee’s fees or any other claims against the liquidation proceeds. Also, assume that the mortgage bonds are secured by the entire amount of fixed assets. What would each claimant receive from the liquidation distribution?
