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Bankruptcy, Reorganization, & Liquidation

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Is a corporate bankruptcy a legitimate tool to be used by corporate management to enhance the value of the firm? Why do you hold this opinion?

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When a business becomes insolvent (ie. it cannot meet its interest payments due to its creditors), two things may happen: (1) the business may enter into voluntary liquidation bankruptcy or its creditors may force it into liquidation bankruptcy (chapter 7 liquidation bankruptcy); or (2) it may file for bankruptcy protection (chapter 11 reorganization). Under chapter 7, all of the business's assets and debts will be place under the control of a bankruptcy trustee, who well sell the assets in order to pay back the businesses creditors. Under chapter 11, if a business's future cash flows are valued higher than its current assets, a business will be allowed to negotiate a payment plan with its creditors to continue operations.

In both cases, bankruptcy proceedings involve the subrogation of shareholder interests to those of creditors. Shareholders are not given voting rights on any restructuring plan. Typically a business's outstanding shares will be frozen from trading. In a liquidation bankruptcy, shareholders are only entitled to the proceeds ...

Solution Summary

The solution discusses bankruptcy, recognition and liquidation. In particular it discusses if a corporate bankruptcy is a legitimate tool to be used by corporate management to enhance the value of the firm.

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A business can be liquidated for $700,000, or it can be reorganized. Reorganization would require an investment of $400,000. If the company is reorganized, earnings are projects to be $150,000 per year, and the company would trade at a price/earnings ratio 8.0 times. Should the company be liquidated or reorganized.

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