ACCA Strategic Professional · Advanced Financial Management · Financial reconstruction

A distressed company has a going-concern value of $40 million. Liquidation would realise $25 million. Debt is $35 million, secured. Which statement best explains why secured creditors may rationally accept a reconstruction in which they exchange part of their debt for equity?

Secured creditors would recover only $25 million of the $35 million owed on liquidation, whereas the going-concern value is $40 million. A reconstruction that preserves the business can therefore give them a better outcome than liquidation, so they may rationally accept a debt-for-equity exchange.

ABecause equity always ranks ahead of debt on liquidation
BBecause the debt would be fully repaid on liquidation anyway
CBecause liquidation recovers only $25 million of $35 million owed, while keeping the firm going preserves more value for themCorrect
DBecause the going-concern value is lower than the liquidation value

Explanation

Liquidation gives secured creditors $25m against $35m owed, a loss of $10m. The going-concern value of $40m exceeds this, so a reconstruction that keeps the firm alive can give them more than liquidation would. The other options misstate the ranking or the values.

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