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Deciding Whether to Acquire or Liquidate Procras Corporation

Sharon Scotia, CFO of Rome Industries, must decide what to do about Procras
Corporation, a major customer that is technically insolvent. Rome Industries is
a large plastic-injection-molding firm that produces plastic products to customer
order. Procras Corporation is a major customer of Rome Industries that designs
and markets a variety of plastic toys. As a result of mismanagement and inventory
problems, Procras cannot pay its bills as they come due. Among its unsecured
debts are total past due accounts of $1.9 million owed to Rome Industries.

Procras is attempting to restructure under the terms of the Companies
Creditors Arrangement Act (CCAA). However, given the company's high debt
load and other significant financial problems, a restructuring will likely not be
possible. As a result, the company will likely be declared bankrupt.

Recognizing that it probably cannot recover the full $1.9 million that Procras
Corporation owes it, the management of Rome Industries has isolated two mutually exclusive alternative actions: (1) acquire Procras through an exchange of
common shares or (2) let Procras be liquidated and recover Rome Industries proportionate claim against any funds available for unsecured creditors.
Romeâ??s management feels that acquisition of Procras would have appeal in
that it would allow Rome to integrate vertically and expand its business from
strictly industrial manufacturing to include product development and marketing.
Of course, the firm wants to select the alternative that will create the most value
for its shareholders. Charged with making a recommendation as to whether
Rome should acquire Procras Corporation or allow it to be liquidated, Ms. Scotia gathered the following data.

Acquire Procras Corporation Negotiations with Procras's management and
board have resulted in a planned ratio of exchange of 0.1 share of Rome
Industries for each common share of Procras. Romeâ??s common shares are currently trading for $32.00 per share. Rome will also acquire all of Procras's liabilities. Procras has 60,000 common shares outstanding. With proper management in place, Sharon Scotia believes that Procras could generate incremental after-tax operating income of $180,000 per year for an indefinite future for Rome Industries. Rome's cost of capital is 12 percent; this rate will be used to analyze the acquisition of Procras.

Liquidate Procras Corporation Procras's secured and unsecured creditors both
voted to reject the company's Plan of Arrangement and the firm was immediately
declared bankrupt. The firm's pre-bankrupt balance sheet is provided below.
After analyzing the firm's assets, the company's court-appointed receiver expected
to be able to liquidate the current assets for $2,200,000 and the fixed assets for
$700,000. The court and trustee fees associated with the CCAA process total
$250,000. These must be fully paid from the proceeds from the liquidation. The
accrued wages, unpaid source deductions, and income taxes payable must also
be fully paid from the liquidation proceeds.

The secured creditors have agreed to accept $0.95 per $1.00 owed. The line
of credit is secured by the company's inventory and receivables, but given the
decline in value of these two assets, the bank that holds the line of credit has
CHAPTER CASES 29agreed to accept $0.65 per $1.00 owed. In both cases, these secured creditors have agreed to have the unpaid amounts written off; they will not become part of the unsecured creditor pool. The unsecured creditors will share equally in the remainder of the proceeds from the liquidation. The common shareholders have been promised nothing from the liquidation process.

(-->See Procras Corporation Pre-Bankrupt Balance Sheet with Attachement File)

a. Determine the value of Procras Corporation to Rome Industries. What is the
net present value of the acquisition? Is synergy created? Comment.

b. From the information provided in the case, determine and show how the proceeds from the liquidation will be allocated among the various parties owed
money. What is the total amount the unsecured creditors will share from the
liquidation? How much will they receive per $1.00 owed?

c. How much, if any, will Rome Industries recover of its $1.9 million balance
due from Procras Corporation as a result of the liquidation of Procras?

d. Compare your findings in b and c, and make a recommendation for Rome
Industries with regard to its best actionâ?"acquisition of Procras or its liquidation.

e. Which alternative would the shareholders of Procras Corporation prefer?


Solution Preview

Rome Industries
Evaluation of whether to acquire or Liquidate Procras Corporation

Part a

The incremental cash flows to Rome industries will be $180,000 for idefinite period
The cost of capital of the Rome industries is 12%
Expected benefits from future earnings(180,000/0.12) NPV 1,500,000 The present value of future earnings for an indefinite period

This is the maximum amount which can be offered to the Procras corporation on the basis of its earning potential.

The agreement was entered to issue 0.1 shares in Rome industries for every 1 share in Procras corporation.

Number of shares to be issued to Procras corporation=shares in procras*share exchange ratio 6000 shares

Current market value of Rome industries is $ 32 $32

Consideration offered to Procras corporation 192,000

The consideration offered to Procras corporation is much less than the expected benefits from its acquisition, which means that the shareholders of Rome industries will get ...

Solution Summary

The expert provides a decision whether to acquire or liquidate Procras Corporations.