Lecture 5 - Financial distress

Question 1

What is financial distress?

Answer 1

Financial distress occurs when a firms operating cash flows are not sufficient to satisfy current obligations
Often forces corrective action and can lead to default and financial restructuring

Question 2

Symptoms of financial distress

Answer 2

Losses
Layoffs
Resignations
Plant/store closings
Plummeting share prices

Question 3

Why would a firm experience financial distress?

Answer 3

High leverage ratio
Poor operating performance
Recession

Question 4

Insolvency

Answer 4

The inability to pay debts
Value based insolvency occurs when a firm has negative net worth
Flow based insolvency occurs when operating cash flow is insufficient to meet current obligations

Question 5

Two options for a firm that cannot emerge out of financial distress

Answer 5

Liquidation
Reorganisation

Question 6

Liquidation

Answer 6

Termination of the firm involving selling the assets of the firm for salvage value
The process are distributed to creditors in order of established priority

Question 7

Reorganisation

Answer 7

Keeping the firm a going concern
Sometimes involving issuing new securities to replace old securities

Question 8

What happens in financial distress?

Answer 8

Asset expansion policies
Financial policies
Wind up company
Operational contraction policies

Question 9

3 sections of bankruptcy law

Answer 9

Liquidation
Priority of claims
Administration

Question 10

Liquidation

Answer 10

Termination of the firm
Fire sale of the assets and transfer proceeds to the creditors
Winding up order

Question 11

Priority of claims

Answer 11

Distribution of liquidation proceeds in the following priority:

1. Admin expenses associated with liquidating the bankrupts assets
2. Unsecured claims arising
3. Wages, salaries ad commissions
4. Contributions to employee benefit plans
5. Consumer claims
6. Tax claims

Question 12

Administration

Answer 12

The administrator attempts to restructure the liabilities, look for a buyer for the whole business or break it up into viable parts
Admin strategies include debt for equity swaps

Question 13

Prepacks

Answer 13

Process of selling the assets of a company immediately after it has entered administration

Question 14

Advantages of Prepacks

Answer 14

1. Firm emerges quickly with less cost
2. Employees usually transferred
3. Greater amount for assets due to business continuity