Crafting a bankruptcy plan of reorganization requires an estimate of enterprise
ID: 2724506 • Letter: C
Question
Crafting a bankruptcy plan of reorganization requires an estimate of enterprise value even though there is little definite information about the future.
1- Usually a free cash flow value is estimated from a pro forma statement and capitalized into an enterprise value using a cost of capital estimate. Why must this capital cost estimate be identical to the assumed rate of interest on any bonds created?
2- A new capital structure is usually developed in a plan of reorganization. In what situation would the plan be all equity and no debt?
Explanation / Answer
(1) The capital cost must be estimated to be identical to the assumed rate of interest on any bonds created. The reason is that the spendings of a firm depends upon the rateof interest it possess. There are many changes brought in the market like price, quantity of product, etc which is based upon the cost of production that is affected by the rate of interest.
(2) The situation where the plan would be all equity and no debt would be the time when there is restructuring of the organisation. The changes brought in the working of the firm would require new ideas and business techniques to establish a market.