Bankruptcy and Corporate Restructuring

Ratio Analysis

Liquidity Ratios

Current ratio= current assets/ current liabilities

This ratio evaluates the ability of the company to meet its short term obligations (Smart & Gitman 2004).

The ratio indicates that the company was able to meet its short term obligations for each of the years. This is because the value of current assets was higher than the value of current liabilities. A further analysis on the ratio gives the following trend;

The trend of the ratio shows that the company was at risk of not meeting its current obligations before filing for bankruptcy. However, from April, the liquidity position of the company significantly improved.

Quick ratio= (current-inventory/stock)/ current liabilities

This ratio indicates the ability of the company to convert its assets to cash so as it can meet its short term obligations. 

A further analysis on the quick ratio shows the following trend;

Similarly to the current ratio, the position of the company improved after it filed for bankruptcy.

Profitability ratios

Gross profit margin = value of gross income/ value of sales

This ratio indicates the margin of gross profit that was raised from the sales revenue (Berk & Demarzo 2007).

The company’s gross profits declined significantly from 1982 up to 1985. After this, the gross profit levels significantly improved. Sales also were declining until 1985; after which they improved. As such, the trend analysis of the gross profit margin is as follows;

During the years 1982, 1983, and 1985, the gross profit was negative; as a result, the ratio was also negative.

Net profit margin ratio = value of net income / value of sales

This ratio evaluates the amount of sales that is converted to net income after all the expenses, taxes, and interest have been accounted for.

The company had negative net income from the year 1982 to 1987. As a result, the ratio indicates that the value of the sales converted to net income was negative. Furthermore, the ratio indicates that the company had been incurring high expenses compared to its revenues. The trend analysis shows the value of the ratio as follows;

The company’s ratio was worst during 1985 when it filed for bankruptcy. However, after this, the company’s position started improving.

Financial Leverage Ratios

Total debt to assets ratio= value of total debt/ value of total assets

This ratio evaluates the financial leverage position of the company. That is whether the company’s assets were able to cover the total debt (Berk & Demarzo 2007).

According to the above ratio, the company’s assets could not cover the total debt. As a result, the company was at risk of undergoing bankruptcy. The trend analysis of the ratio is as follows;

Total debt to equity ratio = value of total debt/ total value of equity

The ratio evaluates whether the amount of total debt has been covered by total equity.

The value of total equity covered total debts up to 1984. However, from 1985 to 1988 the total equity was negative, and thus, the ratio was negative. This can be attributed to negative retained earnings from the income statement. The trend analysis shows the following;

Return Ratios

Return on equity ratio = value of net income/ total equity (Smart & Gitman 2004)

The ratio evaluates the amount of return that equity shareholders gain from the net income. The ratio is given as a percentage.

A further analysis of the return on equity ratio shows the following trend;

The graph illustrates the impact of the return to equity shareholders that was the highest in 1985 although the amounts of net income and equity were negative.

Return on assets ratio = value of net income / value of total assets (Ross & Jaffe 2002).

The trend analysis on the ratios shows the following;

Activity ratios

Inventory turnover ratio = value of cost of goods sold/ value of inventory.

The value of total assets turnover = sales/ total assets

Z-Score

The Z-Score illustrates whether a company is financially healthy. As such, it gives a single value in each year. The value below 1.8 indicates that the company is at risk of becoming bankrupt over the next two years. If the value is above 3, the company is financially healthy. The Z-Scores are calculated by the below formula

Z= 1.2(Working Capital/Total Assets) + 1.4(Retained Earnings/ Total Assets) + 3.3(EBIT/ Taxes) + 0.6(MVOE/Total Liabilities) +1.0(Sales/Total Assets) (Smart & Gitman 2004)

The above graph illustrates the trend of the calculated Z-Scores. It shows that since 1981 the company was at a risk of becoming a bankrupt. The company’s financial problems were worsening until 1986 before it filed for bankruptcy.  However, the company’s financial matters improved from 1987 to 1990 although it was still at a risk of becoming a bankrupt.

Stock Price Performance Analysis

The above were the stock prices of the company by the end of each year from 1980 to 1990 for the period ended at December 31^st. The graphical analysis illustrates the trend in the stock prices that declined from 1983 to 1988. The prices increased slightly in 1989; however, in 1990, the prices were split and ended at a lower price (Berk & Demarzo 2007).

The company filed for bankruptcy under chapter eleven of the Federal Bankruptcy Code in the US district court. The bankruptcy was filed on 16^th April, 1985. The stock prices before and after the filing of bankruptcy were as follows;

The stock price was at $11.75 on 8^th April and reduced to $8.75 on 15^th April. On the day the company filed for bankruptcy, the stock price was at $7.52. As a result of filing for bankruptcy, the price fell again to $6.62. However, because of the fact that the Fed had protected the company against all its liabilities, the company’s stock price improved to $8.62.

Weighted Average Cost of Capital

This is a discount rate averaged from the expected returns of different sources of capital. A higher value of the discount rate is expected in this analysis. The WACC is calculated as follows;

WACC= market value of equity/ market value of equity and debt * cost of equity+ market value of the debt/ market value of debt and equity * cost of debt (Smart & Gitman 2004).

Cost of equity is calculated using capital assets pricing model. This will be calculated as follows;

The unlevered beta = market value of stock/ market value of debt + market value of preferred stock (Berk & Demarzo 2007).

Return on equity= risk free rate+ beta *(risk premium-risk free rate) (Ross & Jaffe 2002).

As such, the risk free rate and the risk premium can be assumed to be 4% and 7% respectively (Vuuren, 1998). The risk free rate has been obtained from the lowest yielding government bonds in the steel industry during the years 1980-1989 as presented by the US treasury. The value of the risk premium is the industrial average from the steel industry in 1980-1989.

Return on equity= 4% + 1.55%* (7%-4%) = 8.65%

WACC= 250/1218* 8.65%+ 968/1218*19.55%= 17.31%

The value of beta is 1.55%, and it explains the high level of volatility in the steel industry, leading to uncertainties in some companies (Vuuren, 1998). The value resulted from the covariance of the S&P 400 and the stock prices divided by the variance of the S&P 400 index level. The weighted average cost of capital is evaluated through considering the cost of debt and equity. 

Projected cash flows

The above analysis shows the projected income statement of the company. The revenues of the company are expected to grow at a rate of 5%. This is attributed to the market conditions and the aggressiveness of management in order to come out of bankruptcy and secure some debts. The costs of goods sold will also increase. However, the increase in the costs will be at a lower rate of 3% given the economies of scale in purchasing more goods (Smart & Gitman 2004).

The is using the reducing balance approach of depreciation, as such the depreciation will be reducing approximately at  a rate of 1%. The non-operating income of the company has been increasing over the previous decade and is expected to continue. As such, the non-operating income is approximate to increase by 2%. As a result of filing for bankruptcy, the company was not paying any interest expenses. However, it is projected that the company will recover from bankruptcy till the second year in the new decade. As such, the company will incur interest costs that are expected to increase at a modest rate. In addition, the company is making profits that are taxable at the provision rate of 30% (Ross & Jaffe 2002).

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