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| | SOLUTION: |
| A) | Verbrugge Publishing Company |
| | Balance Sheet |
| | Assets | Amount | Liabilities | Amount |
| | Current Assets | $ 159.00 | Current Liabilities | $ 42.00 |
| | Net Fixed Assets | $ 153.00 | Advance Payments | $ 78.00 |
| | Goodwill | $ 15.00 | 8% Debentures | $ 90.00 |
| | | | Reserves | $ 6.00 |
| | | | $2.4 Preferred Stock, par value $37.50 | $ 45.00 |
| | | | Common Stock, $1.50 par value | $ 9.00 |
| | | | Retained Earnings | $ 57.00 |
| | | $ 327.00 | | $ 327.00 |
| B) | Verbrugge Publishing Company |
| | Income Statement |
| | Particulars | Amount |
| | Net Sales | $ 540.00 |
| | Operating Expense | $ 516.00 |
| | Net Operating Income | $ 24.00 |
| | Other Income | $ 3.00 |
| | Interest Expense | $ 7.20 |
| | Earnings before tax | $ 19.80 |
| | Taxes @ 50% | $ 9.90 |
| | Net Income | $ 9.90 |
| | Dividend on Preferred Stock | $ 2.88 |
| | Income available to common stockholders | $ 7.02 |
| C) | The earnings required before the recapitalization is $7.8 million/(1 - 0.5) = $15.6 |
| | million. We divide the preferred dividends by (1 - T) since $15.6 million must be |
| | earned to provide the $7.8 million needed after-tax. After recapitalization, the |
| | firm requires $2.9 million/0.5 = $5.8 million to cover the preferred dividend |
| | payment, and $7.2 million to cover the interest expense for a total of $13.0 |
| | million. Since interest expense is tax deductible, only $7.2 million in pre-tax |
| | earnings are required to cover the interest expense. Thus, required earnings will |
| | decrease by $15.6 million - $13.0 million = $2.6 million if the reorganization |
| | takes place. |
| D) | Before reorganization: |
| | Debt Ratio = ($42 + $78) / $336 |
| | Debt Ratio | 35.71% |
| | After reorganization: |
| | Debt Ratio = ($42 + $78 + $90) / $327 |
| | Debt Ratio | 64.22% |
| | The reorganization shall not take place because the debt ratio has increased due to the reorganization. |
cybacatx
finance-8361457.xls
