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FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies

A distressed firm has enterprise value as a going concern of 80 and a liquidation value of 55. Total debt is 100. A workout can be agreed only if creditors collectively prefer it to liquidation. Creditors' aggregate recovery under the proposed workout, via a debt-for-equity swap giving them 70% of the equity, is based on the going-concern value. What is their aggregate value, and does the workout beat liquidation?

Creditors receive 70% of equity valued at the 80 going-concern value, which is 56. That exceeds the 55 liquidation value, so in aggregate they prefer the workout. Using 80 assumes they own everything, and 70 wrongly applies the percentage to debt face value.

  1. A56, yes, it beats liquidation of 55Correct
  2. B80, yes, because creditors receive all going-concern value
  3. C70, yes, because they receive 70% of debt
  4. D45, no, because 100 minus 55 is the shortfall

Explanation

Creditors receive 70% of equity worth 80, so 0.70 x 80 = 56. This exceeds liquidation value of 55 by 1, so creditors in aggregate prefer the workout. Option 80 wrongly gives them 100% of value; 70 applies the percentage to the debt rather than firm value.

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