Kimberly MacKenziepresident of Kims Clothes Inc., a medium-sized manufacturer of womens casual clothingis 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 Kims Clothes $65,000 for spring sportswear that was delivered to the store just 2 weeks ago. Kims concern arose from reading an article in yesterdays Wall Street Journal that indicated Russ Brothers was having serious financial problems. Moreover, the article stated that Russ Brothers management was considering filing for reorganization, or even liquidation, with a federal bankruptcy court.

Kims immediate concern is whether her firm will collect its receivables if Russ Brothers goes bankrupt. In pondering the situation, Kim has also realized that she knows nothing about the process that firms go through when they encounter severe financial distress. To learn more about bankruptcy, reorganization, and liquidation, Kim has asked Ron Mitchell, her firms chief financial officer, to prepare a briefing on the subject for the entire board of directors. In turn, Ron has asked you, a newly hired financial analyst, to do the groundwork for the briefing by answering the following questions.

a)

(1) What are the major causes of business failure?

(2) Do business failures occur evenly over time?

(3) Which size of firm, large or small, is more prone to business failure? Why?

b) What key issues must managers face in the financial distress process?

c) What informal remedies are available to firms in financial distress? In answering this question, define the following terms:

(1) workout

(2) restructuring

(3) extension

(4) composition

(5) assignment; and

(6) assignee (trustee).

d) Briefly describe U.S. bankruptcy law, including the following terms:

(1) Chapter 11

(2) Chapter 7

(3) trustee

(4) voluntary bankruptcy; and

(5) involuntary bankruptcy.

e) What are the major differences between an informal reorganization and reorganization in bankruptcy? In answering this question, be sure to discuss the following items:

(1) common pool problem

(2) holdout problem

(3) automatic stay

(4) cramdown; and

(5) fraudulent conveyance.

f) What is a prepackaged bankruptcy? Why have prepackaged bankruptcies become more popular in recent years?

g) Briefly describe the priority of claims in a Chapter 7 liquidation.

h) 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 debentures		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 trustees 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?