What are the direct and indirect costs of bankruptcy? Briefly explain each.

| January 23, 2015

Description of Costs

1. What are the direct and indirect costs of bankruptcy? Briefly explain each.

2. Chrysler’s financial structure in August 1983 was as follows:

Security Number of Units
Outstanding
Price per
Unit
Market
Value
Common stock

115,000,000

$26.00

$2,990,000,000

Preferred stock

10,000,000

32.5

325,000,000

Warrants

14,400,000

13.5

194,400,000

Bonds

2,000,000

650

1,300,000,000

Due to large losses incurred during 1978–1981, Chrysler had $2 billion in tax-loss carryforwards; therefore, the next $2 billion of income was free from corporate income taxes. At the time, the consensus of security analysts was that Chrysler would not have cumulative profits in excess of $2 billion over the next five years. Most of the preferred stock was held by banks. Chrysler had agreed to retire the preferred stock over the next few years. Chrysler had to decide whether to issue debt or sell common equity to raise the funds needed to retire the preferred stock. If you were Lee Iacocca, what would you have done? Why?

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