Baxter Manufacturing, Inc., has an outstanding note payable with a balance of $2,000,000. The note calls for 14 semi-annual payments of $183,141 based on a 7% interest rate. The company has experienced declining markets and serious cash flow problems. In an attempt to improve cash flows, the company is negotiating a restructuring of the above note. The following alternatives are being considered:
a. Dispose of a parcel of land that the company had purchased as a future plant site. However, given current conditions, the likelihood of relocation seems remote. The site has a book value of $400,000 and a current market value of $550,000. Transaction costs to dispose of the land are estimated to be $35,000. The net proceeds from the sale of the land would be used to reduce the note payable. The balance of the note would be restructured with 14 semiannual payments of $100,000 each.
b. Dispose of the parcel of land as set forth above and apply $300,000 of the net proceeds to reduce the note. The balance of the note would be restructured with 20 semiannual payments of $90,000 each.
Required
1. Assuming that current borrowing rates are 6%, compare the income statement and balance sheet effect of the two alternatives assuming
(a) A non-bankruptcy approach and
(b) A bankruptcy approach.
2. Given a non-bankruptcy approach and ignoring the effect on the financial statements, discuss which alternative would be preferred.