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Principles of Finance Videos 166 videos

Principles of Finance: Unit 1, Company Formation, Structure, Inception
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How is a company... born? Can it be performed via C-section? Is there a midwife present? Do its parents get in a fight over what to name it? In thi...

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Principles of Finance: Unit 1, Alex, That’s Finance Potpourri for $500
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Okay, so you want to be a company financial manager. It's basically up to you to make money for the shareholders. It would also be swell if you mad...

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Principles of Finance: Unit 5, The Process of Bankruptcy 7 Views


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Description:

The process of bankruptcy is a process we here at Shmoop hope to never personally experience, but we're certainly willing to teach you about.

Language:
English Language

Transcript

00:00

Principles of finance a la shmoop... the process of bankruptcy

00:07

so what happens when a company goes bankrupt well let's bring back our

00:12

little infamous sauce company and jiggle the numbers the company was doing just [People celebrating company opening]

00:16

fine unleveraged that is it had no debt a hundred million dollars in cash on the

00:22

books and was growing at about 10 percent a year not awesome but good

00:26

solid tons of room to do small things with their cash and you know move on but

00:31

no the CEO had to be a hero instead and well he turned it into a huro, you know [Person grabs sauce bottle]

00:37

those things in New York and the things that they push up on the street....

00:39

so the company took out a whole bunch of debt bought a

00:44

bunch of competitors and well here's the sorry tail yeah so what is the story [Sauce boiling in a pot]

00:49

here the numbers are telling us well the company took out two billion dollars in

00:53

loans to vastly overpay to buy out competitors and it never locked in its

01:00

interest rate so in the middle year it paid seven and a half percent interest

01:04

on two billion dollars and it eked out 50 million of profits which is just

01:09

dandy but then in the next year without the original management sticking around

01:14

well the acquisition sucked revenues went down dramatically and the company [Revenues of sauce company decline]

01:19

actually lost money big money well problems were exacerbated by the

01:23

fact that the company hadn't locked in interest rates on the two billion

01:27

dollars it owed so when prevailing rates went up another two and a half percent [prevailing rates rises]

01:32

well the company found its new rate to be ten percent on the two billion

01:36

dollars it still owed and with two hundred million dollars in interest

01:40

expenses while the company lost a hundred fifty million dollars which then

01:45

chewed up all of the excess cash it originally had and in the following year

01:50

it would in fact fail to be able to pay even its interest expenses yeah

01:55

bankruptcy so what happens now well in essence the lenders the people who

01:59

loaned him the money own the company as part of a contract they promised when

02:03

they sign the two billion dollar bond paperwork but the lenders don't want to

02:07

own the company lenders like golf and long lunches they don't like having to [People having lunch]

02:12

run you know a sauce company especially one that is dying so the lenders have a

02:17

few choices in reality most of the time banks don't

02:21

take risk that is they "renegotiate the terms of the loan" with the

02:27

company in this case well the bank might add to the principal amount borrowed [Principal amount increased]

02:31

like make it 2.3 billion so that the company has time to shut down

02:35

unprofitable divisions has enough capital to pay the lenders their

02:39

interest and keep operating essentially the bank's loan the company

02:43

an additional three hundred million dollars so that the company can pay back

02:47

the banks the interest next year and keep going and then you know the bank [Man playing golf]

02:51

management can keep working on their putting and short game and hopefully

02:55

retire soon well the lenders are making the bet here that the company can figure

02:59

out a way to survive long enough to pay back the owners debt that it's carrying

03:03

and remember lenders don't care about the equity here they just care about

03:08

getting back to their debt because in this illustration the lenders aren't [Money transfers from sauce bottles to lenders]

03:12

actually taking possession of the company it's still run by the previous

03:16

players although with a new CEO at the helm and things you know continue but [Employees of the sauce company]

03:21

there are other times when banks will actually take possession of a company

03:25

and they have a choice if there are assets to be auctioned off well then

03:28

maybe they call eBay and do that you can imagine in this case the old sauce [Sauce pot listed for sale on eBay]

03:33

company might have been worth a billion dollars to you know Geico Heintz and

03:38

Warren Buffett...Warren's good for his money he's got the cashola to pay day

03:42

one so now at least the two billion dollars have failed debt after selling

03:46

off that division is down to "only" a billion dollars but there is

03:51

still the acquisition which they paid two billion dollars to buy and now [man holding pitta bread]

03:55

worth probably something less than a billion dollars well maybe then the bank

03:59

owners auction it off and collect six hundred fifty million, write off the

04:03

remaining 350 and as bad loans go and it's not so terrible and hopefully they

04:08

live to fight another day and remember they collected some

04:11

interest along the way so it's not like they lost everything although this was

04:14

not good all right well often in addition all of the above

04:17

there are huge tax losses in these situations which are actually highly

04:21

valuable believe it or not so let's say an acquirer has a thirty percent tax [30% tax rate of enquirer on whiteboard]

04:25

rate like it's Microsoft or Google or General Foods they're paying 30 percent

04:30

tax and the acquired piece bolted on unsuccessfully to the sauce

04:34

company had 700 million dollars in accumulated losses well if the acquirer [Sauce company with 700 million dollar losses]

04:39

has say three billion dollars in pre-tax or operating profits in a given year

04:44

well often that 700 million dollars in "phantom" tax losses can be

04:49

used as a direct tax edge specifically that means that on its own the three

04:54

billion dollars of profits would carry a 30 percent tax rate or 900 million

04:57

dollars in taxes paid but the acquired piece would essentially remove 700 [700 million dollar losses highlighted]

05:02

million dollars of those profits so that on a tax basis the highly profitable

05:06

companies 3 billion dollars in profits looks to the IRS in a more like 2.3

05:12

billion dollars in profits that is the 700 million dollars is subtracted from

05:16

the company's profits the profitable successful ones profits and that company

05:20

now pays tax on 2.3 billion of 30% or 690 million instead of that whole

05:25

shabang 3 billion it's not quite that simple in real life but you get the gist

05:30

here the old taxes were 900 million the new ones are now 690 million so the [Old and new taxes]

05:36

"asset" of the tax loss that it acquired in the acquisition ended up

05:41

being worth 200 million dollars in tax savings to the acquirer sounds crazy but

05:46

that's how things work sorta welcome to America [Man holding up small America flag]

05:49

no kneeling but yes you future lawyers out there technically this isn't exactly

05:53

how it works and there are tons of tests that tax loss transfers have to meet

05:58

like it has to be the same basic product in the same basic industry in the same

06:02

basic region and so on but for our purposes the key idea here is that the

06:06

tax loss is actually worth something and yes that's odd but true and that's one

06:11

way you go bankrupt you borrow too much money you can't pay it back and then [Bank transfers money to a person]

06:15

well the banks end up owning whatever it is you're sauce company or towel

06:18

distribution company or whatever it is you do and if you really want the nitty

06:22

and the gritty we have videos on chapter 7 versus chapter 11 style bankruptcy

06:26

whole bunch of flavors of the B word you just know you want to avoid it [Selection of ice cream flavors]

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