Cumberland Worldwide Corporation (A)
Senior management seems to be convinced that the best way to build value for CW's claimants is to invest significant amounts in the rejuvenation of CR. What are the value implications for the claimants if the rejuvenation plan is successfully implemented? (at the time of the case, the yield on long-term treasury securities was 8%; CR's long-term borrowing rate, as an independent company, would have been 10%, and its beta would have been 1.1) what risks are involved in the plan to rejuvenate CR?
Cumberland World Corporation is a company which was highly indebted. It was facing many problems for example; fixed payments of debts, resignation of key the position holders, continuous loss etc. Tad Morton executive vice president, chief financial officer and member of board of directors of Cumberland Worldwide Corporation who with newly appointed management group proposed a recapitalization plan which would help the company to reduce its debts which would result in the reduction of its fixed cost. It also proposed to repay the previous debts by taking new loans from the creditors. It would help the company to reschedule the payments of debts according to its feasibility. If the proposed plan would be implemented then it would keep the company from going bankrupt (which is the most crucial current problem for the company).
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Secondly, it would also help the company to retain its goodwill in the credit market. This plan would also help the company to regain its old position in the market. However, calculating the risks involved, firstly the company had to pay the higher interest then it was previously paying. Secondly, the plan could turn out a failure which would lead the company to bankruptcy.
Another issue that Cumberland World Corporation might be facing is the risk of loan disapproval from the financial institutions. Because the financial institution check the Debt to Equity Ratio (Long Term Debt/Equity) before granting credit facility to the borrowers. This ratio might not meet their requirements because the Loans that the company has taken are higher than the Share Capital. Another ratio that is calculated by the financial institutions before disbursing the short term loan is Current Ratio (Current Assets/Current Liabilities). This ratio is calculated to check the pay back ability of the borrower. Banks hesitate to lend money if this ratio does not meet their standard.
The Company has not been able to pay dividend to its shareholders so it is quite possible that the stake holders might not be interested in buying furthers shares of the Company. So it can be said that this proposed plan can prove to be difficult and risky when implanted.
Evaluate Morton's recapitalization plan. Would it, if implemented, result in a capital structure that meets the ongoing needs of the business? Which claimants would find it appealing, which unappealing? As a bank lender, would you subscribe to Morton's premise that all of the claimants must share the pain of the restructuring?
As the Cumberland Worldwide Corporation was highly indebted, it had to restructure its capital plan. For this purpose, Tad Morton executive vice president, chief financial officer and member of board of directors of Cumberland Worldwide Corporation proposed a relatively better plan than to follow the bankruptcy plan. The amount of pain to be suffered by the claimholders is much more appropriate as the preferred stockholders would suffer more as compared to others.
Renewal of the debt amortization schedule would give the company a breakthrough in repayments of the debts as it would not require any principle payments for the period of three years. Previous debts had the drawbacks of long maturities which resulted in long term fixed costs. Whereas, the new debts had higher interest rates but short maturities.
Currently, the business had higher variable and fixed cost which was mainly due to high debt that were the repayments of debt and payments of interest. Recapitalization plan if implemented would reduce the company debt from 615 million dollars to 328 million dollars and it would increase the equity from the negative number from 272 million dollars which would help to meet the on-going need of the business.
The recapitalization plan proposed by Morton would be more appealing to the subordinate creditors and unsecured senior creditors because the Cumberland Worldwide Corporation was already behind the repayment of its debts whereas, it would be unappealing for the preferred stockholders for the reason that the preferred stockholders secured stockholders and unsecured stockholders would have an opportunity to invest in this company and to they could have high dividend payout ratio. Company was offering the shares to its existing stockholders on discount that is they had to pay less then the market price of the share.
As a bank lender, I would subscribe to Morton’s proposal that all the claimants must share the pain of restructuring because all the claimants had also shared the profits generated by the Cumberland Worldwide Corporation in good times.
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