The chapter focuses on long-term debt and leasing as a means of growth and capital improvement. Appendix 16A spotlights what happens when firms are financially distressed due to the burdens of debt payments.

Please consider the following questions:

1. What is the reason an investor would choose bonds or choose stocks for an investment?

2. Read Appendix 16A beginning on page 533.

A. Hopefully, your firm or a firm you have invested in will never face financial distress; however, it does happen for various reasons. Briefly articulate in your own words, the different forms of distress/bankruptcy an organization may face (e.g., not all firms that file for bankruptcy will close their doors). What is the difference? Note: the reason this question is asked is that there is always a great deal of confusion surrounding financial distress, bankruptcy, and liquidation and it important that financial managers have knowledge of the risks and rewards of debt and debt management.

B. In your own words, summarize the difference between an internal and external reorganization under formal bankruptcy procedures.

C. What is the order of claims during a bankruptcy? Do you agree with this order? Does it make a difference to you as a prospective investor? Why or why not?

Chapter 16 Long-Term Debt and Lease Financing APPENDIX I 16 A the Financial Alternatives for Distressed Firms A firm may be in financial distress because of technical insolvency or bankruptcy. The first term refers to a firm's inability to pay its bills as they come due. Thus, a firm may be technically insolvent, even though it has a positive net worth; there sim- ply may not be sufficient liquid assets to meet current obligations. The second term bankruptcy, indicates the market value of a firm's assets are less than its liabilities and the firm has a negative net worth. Under the law, either technical insolvency or bankruptcy may be adjudged as a financial failure of the business firm. ent he te is Many firms do not fall into either category but are still suffering from extreme financial difficulties. Perhaps they are rapidly approaching a situation in which they cannot pay their bills or their net worth will soon be negative. Firms in the types of financial difficulty discussed in the first two paragraphs may participate in out-of-court settlements or in-court settlements through formal bank- ruptcy proceedings under the National Bankruptcy Act. Out-of-court settlements, where possible, allow the firm and its creditors to bypass certain lengthy and expensive legal procedures. If an agreement cannot be reached on a voluntary basis between a firm and its creditors, in-court procedures will be necessary Out-of-Court Settlement Out-of-court settlements may take many forms. Four alternatives will be examined. The first is an extension, in which creditors agree to allow the firm more time to meet