Kimberly MacKenzie-president of Kim's Clothes Inc., a medium-sized manufacturer of women's casual clothing- is worried. Her firm has been selling clothes to Russ Brothers
Department Store for more than 10 years, and she has never experienced any problems in collecting payment for the merchandise sold. Currently, Russ Brothers owes Kim's Clothes $65,000 for spring sportswear that was delivered to the store just 2 weeks ago. Kim's concern arose from reading an article in yesterday's The Wall Street Journal that indicated Russ Brothers was having serious financial problems. Moreover, the article stated that Russ Brothers's management was considering filing for reorganization, or even liquidation, with a federal bankruptcy court. Kim's immediate concern was whether or not her firm would collect its receivables if Russ Brothers went bankrupt. In pondering the situation, Kim also realized that she knew nothing about the process that firms go through when they encounter severe financial distress. To learn more about bankruptcy, reorganization, and liquidation, Kim asked Ron Mitchell, the firm's chief financial officer, to prepare a briefing on the subject for the entire board of directors. In turn, Ron asked you, a newly hired financial analyst, to do the groundwork for the briefing by answering the following questions.
a. (1) What are the major causes of business failure?
(2) Do business failures occur evenly over time?
(3) Which size of firm, large or small, is more prone to business failure? Why?
b. What key issues must managers face in the financial distress process?
c. What informal remedies are available to firms in financial distress? In answering this question, define the following terms:
(1) Workout
(2) Restructuring
(3) Extension
(4) Composition
(5) Assignment
(6) Assignee (trustee)
d. Briefly describe U.S. bankruptcy law, including the following terms:
(1) Chapter 11
(2) Chapter 7
(3) Trustee
(4) Voluntary bankruptcy
(5) Involuntary bankruptcy
e. What are the major differences between an informal reorganization and reorganization in bankruptcy?
In answering this question, be sure to discuss the following items:
(1) Common pool problem
(2) Holdout problem
(3) Automatic stay
(4) Cramdown
(5) Fraudulent conveyance
f. What is a prepackaged bankruptcy? Why have prepackaged bankruptcies become more popular in recent years?
g. Briefly describe the priority of claims in a Chapter 7 liquidation.
h. Assume that Russ Brothers did indeed fail, and that it had the following balance sheet when it was liquidated (in millions of dollars):

The liquidation sale resulted in the following proceeds:
From sale of current assets...........................$14,000,000
From sale of fixed assets...............................2,500,000
Total receipts..........................................$16,500,000
For simplicity, assume there were no trustee's fees or any other claims against the liquidation proceeds. Also, assume that the mortgage bonds are secured by the entire amount of fixed assets. What would each claimant receive from the liquidation distribution?

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Current assets Net fixed assets Accounts payable $10.0 $40.0 Notes payable 5.0 0.3 0.5 0.2 $16.0 3.0 Second-mortgage bonds 0.5 Subordinated debentures 4.0 Total long-term debt $75 5.0 (to banks) Accrued wages Federal taxes State and local taxes Current liabilities First-mortgage bonds Preferred stock Common stock Paid-in capital Retained earnings 13.0 2.0 5.5 $21.5 $45.0 Total equity Total assets $45.0 Total claims