Chapter 5: Q1P-f (page 538)

The trustee in the bankruptcy settlement for Titanic Boat Co. lists the following book values and liquidation values for the assets of the corporation. Liabilities and stockholders’ claims are also shown.
Assets
Book value
Liquidation value
Accounts receivables
$1,400,000
$1,200,000
Inventory
$1,800,000
$900,000
Machinery and equipment
$1,100,000
$600,000
Building and plant
$4,200,000
$2,500,000
Total assets
$8,500,000
$5,200,000
Liabilities and stockholder’s claims
Liabilities
Accounts payable
$2,800,000
First lien, secured by machinery and equipment
$900,000
Senior unsecured debt
$2,200,000
Subordinated debenture
$1,700,000
Total liabilities
$7,600,000
Stockholder’s claims
Preferred stock
$250,000
Common stock
$650,000
Total stockholder’s claims
$900,000
Total liabilities and stockholder’s claims
$8,500,000
f. Compute a ratio of your answers in part d and e. This will indicate the initial allocation ratio.

Expert verified

The allocation ratio is 60%.

Step by step solution

Total liquidation value of assets left after deducting administrative costs, unpaid taxes, and satisfying first lien = $4,200,000

Total liquidation value of liabilities after partial cover of first lien = $7,000,000

The allocation ratio is 60%.

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Bailey corporation
Income statement
For the year 20X1
Sales (all on credit)	\(42,680,000
Cost of goods sold	\)32,240,000
Gross profit	\(10,440,000
Selling and administrative expenses	\)4,558,000
Operating profit	\(5,882,000
Interest expense	\)600,000
Net income before taxes	\(5,282,000
Taxes	\)2,120,000
Net income	\(3,162,000

Bailey corporation
Balance sheet
As of December 31, 20X1
Assets
Current assets:
Cash	\)250,000
Marketable securities	\(130,000
Accounts receivables	\)6,000,000
Inventory	\(8,300,000
Total current assets	\)14,680,000
Net plant and equipment	\(13,970,000
Total assets	\)28,650,000
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	\(3,800,000
Notes payable	\)3,550,000
Total current liabilities	\(7,350,000
Long-term liabilities	\)5,620,000
Total liabilities	\(12,970,000
Stockholder’s equity:
Common stock (1,800,000 shares at \)1 par)	\(1,800,000
Capital in excess of par	\)6,300,000
Retained earnings	\(7,580,000
Total stockholder’s equity	\)15,680,000
Total liabilities and stockholder’s equity	\(28,650,000

Liabilities and stockholder’s claims
Liabilities
Accounts payable	\(2,800,000
First lien, secured by machinery and equipment	\)900,000
Senior unsecured debt	\(2,200,000
Subordinated debenture	\)1,700,000
Total liabilities	\(7,600,000
Stockholder’s claims
Preferred stock	\)250,000
Common stock	\(650,000
Total stockholder’s claims	\)900,000
Total liabilities and stockholder’s claims	$8,500,000