Question

Southwestern Wear Inc. has the following balance sheet:

Current assets $1,875,000
Accounts payable $375,000
Fixed assets 1,875,000
Notes payable 750,000
Subordinated debentures 750,000
Total debt $1,875,000
Common equity 1,875,000
Total assets $3,750,000
Total liabilities and equity $3,750,000
The trustee’s costs total $281,250, and the firm has no accrued taxes on wages. The debentures are subordinated only to the notes payable. If the firm goes bankrupt and liquidates, how much will each class of investors receive if a total of $2.5 million is received from the sale of the assets?

Answer 1

If the firm goes bankrupt and liquidates, the common equity will receive $1,849,812.50 and the total debt will receive $368,937.50 from the sale of assets.

Step-by-step explanation:

First, we need to calculate the total debt by summing up the notes payable and the subordinated debentures, so the total debt is $750,000 + $750,000 = $1,500,000.

Next, we subtract the total debt from the total assets to find the total equity. $3,750,000 - $1,500,000 = $2,250,000.

Now, we can determine the distribution of the $2.5 million from the sale of assets.

Since the trustee's costs are $281,250, we subtract that from the $2.5 million, leaving $2,218,750.

Based on the proportions of the total equity, the common equity is $1,875,000 / $2,250,000 = 0.8333.

The remaining proportion is for the total debt, which is 1 - 0.8333 = 0.1667.

Multiplying these proportions with the remaining amount, we find that the common equity will receive $1,849,812.50 ($2,218,750 * 0.8333) and the total debt will receive $368,937.50 ($2,218,750 * 0.1667).