635 Case #4: May 13, 2020 Page 1
University of La Verne
College of Business and Public Management
BUS 635 – Managing Financial Resources Online
Case Study #4 Spring 2020
“Alternative Capital Resources”
Each work is your own; please reference any sources when required. This Case
work represents 15% of your total course grade. Please post to the Case #4 file
folder by Midnight Sunday May 24.
Note: There is no designated format for this Case #4, please present your analysis
in your chosen format.
Question I – Lease Financing (Chapter 19)
The legal definition of "small business" varies by country and by industry. In the
United States, the Small Business Administration establishes small business size
standards on an industry-by-industry basis, but generally specifies a small business
as having fewer than five hundred employees for manufacturing businesses and
less than $7.5 million in annual receipts for most non-manufacturing businesses.
Please explain why leasing as a capital financing alternative is an advantage for
small business.
635 Case #4: May 13, 2020 Page 2
Question II – Managing Financial Resources Start-up (Chapter 18)
If you were creating a business now (today), would you?
Why or why not? How would the topics and discussions of our articles in Week 6
guide your strategies?
What type of business would you choose, how would you finance?
For a business start-up what would be your greatest fear and why?
635 Case #4: May 13, 2020 Page 3
Question III – Bankruptcy or Restructuring (Chapter 24)
“Is It Worth More Dead or Alive?”
Alex Peterson, president of Peterson Investments Inc., was faced with a major
decision. One of the firms that his company had invested in, Durawear
Corporation, was under severe financial distress. It had therefore sent out a
proposal for reorganization, which if approved by a majority of the creditors would
lead to a “pre-pack” in the hope that the company would restructure itself and be
salvaged. Being rather unfamiliar with the various regulations and nuances
associated with corporate bankruptcy, Alex summoned his chief financial officer,
Don Thompson. “I am really stumped on this one, Don”, said Alex, pointing to the
proposal lying on his desk. “First bankruptcy case that I have encountered in my
fifteen years of investing. I’d like you to take a look at the numbers and the
proposal and make a recommendation whether I should vote for or against the
eorganization plan.”
The Durawear Corporation, incorporated in 1985, designed, manufactured,
imported, and marketed various menswear, children’s sleepwear and underwear,
and other apparel products. It sold its products to department and specialty stores,
national chains, major discounters, and mass-volume retailers throughout the
United States. About nine years earlier, when sales were booming, the company
undertook a major business expansion, almost doubling its manufacturing capacity.
The expansion was primarily financed by the issuance of senior notes and
prefe
ed stock. However, due to significantly lower profit margins and declining
demand caused by increasing competition and weak economic conditions, the
company faced negative earnings and poor liquidity conditions during the past
three years.
Initial attempts to cut costs did alleviate the problems a bit, but with debt servicing
costs being fairly high, the company’s cash flows declined sharply. With the senior
notes coming up for redemption within a year, the company’s management was
concerned that they would not be able to refinance the debt nor have the liquidity
to pay off creditors in time. They had therefore embarked upon a voluntary
eorganization plan by which the debt would be exchanged for common stock, if
agreed upon by the majority of creditors. Table 1 shows the latest balance sheet of
the company.
635 Case #4: May 13, 2020 Page 4
Mr. Peterson had purchased $5 million worth of Durawear Corporation’s senior
notes about nine years ago. The industry outlook was good, and the 10.5% yield on
the 10-year notes certainly looked enticing. The company had demonstrated a good
ecord of complying with its interest and dividend obligations, and analysts were
ullish on the performance of its common stock.
In their letter to the creditors, Durawear Corporation’s management had explained
that the cu
ent situation was, in their opinion, temporary, and that if given a
chance to reorganize and restructure, they would do their best to steer the company
ack onto the road to profitability. It was their intention to a
ive an agreement
with the majority of creditors and then go for a prepackaged bankruptcy. The
eorganization plan called for the exchange of XXXXXXXXXXshares of new common
stock for each $1,000 face value of senior debt. The management pointed out that
if the firm was forced to liquidate, its cu
ent assets could probably be sold for
about 40% of book value and its fixed assets would
ing in about $9 million.
However, roughly 20% of the gross proceeds would have to be paid towards
administrative fees and other charges.
After reading the letter and going over the financial statements of Durawear, Alex
Peterson was clearly undecided. On the one hand, it seemed as if the management
team was serious and confident about being able to weather this storm and make
the company profitable once again. On the other hand, Alex was concerned that the
problems could get worse and he could end up with nothing. He was hoping that
his CFO (you) would shed some light on this matter and help him decide whether
Durawear was worth more dead or alive.
635 Case #4: May 13, 2020 Page 5
Table I
Durawear Corporation
Latest Fiscal Year Balance Sheet (000s)
Cu
ent Assets $140,000 Accounts Payable $35,000
Notes Payable $18,000
Net Fixed Assets $20,000 Accrued Wages $1,800
Federal Taxes Due $1,000
State & Local Taxes Due $200
Cu
ent Liabilities $56,000
First Mortgage $10,000
Second Mortgage $2,000
10.5% Senior Notes $14,000
Long Term Debt $26,000
Prefe
ed Stock $3,500
Common Stock $46,000
Paid in Capital $8,000
Retained Earnings $20,500
Total Equity $78,000
Total Assets $160,000 Total Liabilities / Equity $160,000
635 Case #4: May 13, 2020 Page 6
Questions:
1). What are the various ways in which firms can be financially distressed?
What seems to be the main problem at Durawear Corporation?
2). What does the “absolute priority rule” mean? Develop a priority list for
Durawear that would be followed if it were liquidated.
3). Why has Durawear’s management attempted to get a prepackage
ankruptcy?
4). How does insolvency differ from bankruptcy? Which one applies to
Durawear and why?
5). If you were Don Thompson, how would you explain the difference between
ankruptcy reorganization and bankruptcy liquidation to Alex Peterson?
6). Should Alex vote in favor of or against the voluntary reorganization?
Explain why and perform the necessary calculations if you deem necessary.
University of La Verne
College of Business and Public Management
BUS 635 – Managing Financial Resources Online
Case Study #4 Spring 2020
“Alternative Capital Resources” Solutions
Question I – Lease Financing (Chapter 19) Thirty Points
The legal definition of "small business" varies by country and by industry. In the
United States, the Small Business Administration establishes small business size
standards on an industry-by-industry basis, but generally specifies a small business
as having fewer than five hundred employees for manufacturing businesses and
less than $7.5 million in annual receipts for most non-manufacturing businesses.
Please explain why leasing as a capital financing alternative is an advantage for
small business.
Companies typically reflect fixed assets on their financial statements. However, it
is the use of assets that is important, not their ownership per se. One way to obtain
the use of facilities and equipment is to buy them, but an alternative is to lease
them. (Brigham, E. F., & Ehrhardt, M. C. (2017); p XXXXXXXXXXThis is especially true
for small businesses where strategic use of cash flows is of the essence and can
make or
eak a business.
A lease can often be an attractive alternative to purchasing an asset outright:
2
• where a cash monthly payment + interest = puts cash to better use than
making capital investments.
• Leasing obviates the need for a small business to fork up a good chunk of
change upfront; allowing it to use the piece of property in exchange for the
lease payment
• Leasing takes several different forms, of which the five most important are:
1. operating leases: provide for both financing and maintenance. The
lease payments are not intended for the full recovery of the asset. The
lease is typically negotiated for a shorter duration than the expected
life of the asset, allowing the lessor to subsequently lease or sell the
asset. This type of lease includes a cancellation clause. This is an
important consideration to the lessee, for it means that the asset can be
eturned if it is rendered obsolete by technological developments or is
no longer needed because of a change in the lessee’s business.
(Brigham, E. F., & Ehrhardt, M. C. (2017); p. 792)
2. financial, or capital, leases: do not provide for maintenance service,
are not cancelable, and are fully amortized (allowing for the lessor to
have full recovery for the asset). The lessee is generally given an
option to renew the lease at a reduced rate upon expiration of the basic
lease. However, the basic lease usually cannot be canceled unless the
lessor is paid in