Because of consistent losses in the past several years, Eat and Run, a fast-food franchise, is in danger of bankruptcy. Its most current balance sheet follows.

Additional information:

• The fair market value of the marketable securities is $19,000.
• The sale of the accounts receivable to a local bank would produce about $25,000 cash.
• A portion of the inventory originally costing $21,000 is now obsolete and can be sold for $3,000 scrap value. The remaining inventory is worth approximately $30,000.
• Prepaid insurance is nonrefundable.
• In the event of bankruptcy, the property, plant, and equipment owned by Eat and Run would be divided up and sold separately. It has been estimated that these sales would bring approximately $100,000 cash.
• Patents no longer provide a competitive advantage thus the market value is zero.

REQUIRED:
a. The book value (balance sheet assets less liabilities) of Eat and Run is $63,000. Comment on why this balance sheet value may not be a good indication of the value of the company in the case of bankruptcy.
b. If Eat and Run goes bankrupt, what would you consider to be the value of the company?
c. When a company goes bankrupt, the creditors are usually paid off first with the existing assets, and then, if assets remain, the shareholders are paid. If Eat and Run goes bankrupt, would the shareholders receive anything? If so, how much?

Transcribed Image Text:

Assets Liabilities and Shareholders' Equity Cash $ 25,000 $ 42,000 Accounts payable Short-term investments Accounts receivable Salaries and wages payable 15,000 20,000 Accrued payables Notes payable Mortgage payable Common stock Retained earnings Total liabilities and shareholders' equity 35,000 34,000 Inventory Prepaid insurance Property, plant, and equipment Patents 42,000 75,000 10,000 25,000 82,000 50,000 50,000 13,000 Total assets $259,000 $259,000