Question about Liquidation

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The Verbrugge Publishing Company’s 2007 balance sheet and income statement are as follows (in
millions of dollars).

Balance Sheet

Current assets $168 Current liabilities $42

Net fixed assets 153 Advance payments 78

Goodwill 15 Reserves 6

$6 preferred stock, $112.50 par value 135

(1,200,000 shares)

$10.50 preferred stock, no par, callable at $150 9

(60,000 shares)

Common stock, $1.50 par value 9

(6,000,000 shares)

Retained earnings 57

Total assets $336 Total claims $336

Income Statement

Net sales $540.0

Operating expense $516.0

Net operating income $24.0

Other income $3.0

EBT $27.0

Taxes (50%) $13.5

Net income $13.5

Dividends on $6 preferred 7.2

Dividends on $10.50 preferred 0.6

Income available to common stockholders $5.7
Verbrugge and its creditors have agreed upon a voluntary reorganization plan. In this plan, each share of
the $6 preferred will be exchanged for one share of $2.40 preferred with a par value of $37.50 plus one
8% subordinated income debenture with a par value of $75. The $10.50 preferred issue will be retired
with cash.

a. Construct the pro forma balance sheet assuming that reorganization takes place. Show the new
preferred stock at its par value.
b. Construct the pro forma income statement. What is the income available to common
shareholders in the proposed recapitalization?
c. Required earnings is defined as the amount that is just enough to meet fixed charges (debenture
interest and/or preferred dividends). What are the required pre-tax earnings before and after
the recapitalization?
d. How is the debt ratio affected by the reorganization? If you were a holder of Verbrugge’s
common stock, would you vote in favor of the reorganization?

Text Answers

a. Total assets: $327m
b. Income: $7M
c. Before: $15.6
After: $13M
d. Before: 35.7%
After: 64.2%

a. BALANCE SHEET
Current Assets 159
Net Fixed Assets 153
Goodwill 15

Total Assets 327

b. INCOME STATEMENT
Net Sales 540
Operating expense -516
Net Operating Income 24

Other Income 3
EBT 27
Taxes (50%) 13.5
Net Income 13.5
Dividends on $2.40 Stock 2.88
Interest on 8% Debenture 7.2
Net Income (for Shareholders) 3.42

c. BEFORE CAPITALIZATION
Charges
$6 Stock 7.2
$10.40 Stock 0.6
$2.40 Stock 0
8% Debenture 0
Pre-Tax Earnings required 7.8

d. BEFORE
Equity 9,000,000
Debt:
$6 Preferred Stock 135,000,000
$10.5 Preferred Stock 9,000,000
$2.40 Preferred Stock
8% Debenture
Debt-Equity Ratio 16

The debt ratio is a measure of how levered a company is with respect to debt. From the
The debt ratio is a measure of how levered a company is with respect to debt. From the
table above the debt-equity ratio decreased. This is favorable for equity holders because the
potential of claim, which debt holders have on income, has reduced.
It would be wise to vote for the re-organization.
ALANCE SHEET
Current Liabilities 42
Advance payments 78
reserves 6

$2.40 Preferred Stock (Par Value $37.50, 1,200,000) 45
8% Preferred Stock (Par Value $75, 1,200,000) 90

Common stock (1.50 for 6,000,000) 9
Retained earnings 57

327

AFTER CAPITALIZATION

2.88
7.2
10.08

AFTER
9,000,000

45,000,000
90,000,000
15

debt. From the
debt. From the
holders because the