# On December 31, 2017, the Flounder Bank enters into a debt restructuring agreement with Barkley...

## Question:

On December 31, 2017, the Flounder Bank enters into a debt restructuring agreement with Barkley Company, which is now experiencing financial trouble. The bank agrees to restructure a 12%, issued at par, $3,700,000 note receivable by the following modifications:

1. Reducing the principal obligation from $3,700,000 to $2,960,000.

2. Extending the maturity date from December 31, 2017, to January 1, 2021.

3. Reducing the interest rate form 12% to 10%.

Barkley pays interest at the end of each year. On January 1, 2021, Barkley Company pays $2,960,000 in cash to Flounder Bank. Answer the following questions related to Flounder Bank(creditor).

a) What interest rate should Flounder Bank use to calculate the loss on the debt restructuring?

Interest rate | _____% |

b) Compute the loss that Flounder Bank will suffer from the debt restructuring.

Loss on restructuring of debt | $_____ |

## Debt Restructuring

When a company experiences difficulty paying a loan and periodic interest, it will negotiate with the bank to enter a debt restructuring agreement. Restructuring is a modification of original terms such as a change in the interest rates, change of payment terms, etc.

## Answer and Explanation:

1. The calculation of loss on the debt restructuring shall be based on the historical rate which is at **12%**

2. The loss on the debt restructuring shall be computed as follows:

Loss on Debt Restructuring = Original value of the note - Revised value of the note

Revised value of the note = Present value of principal loan + Present value of interest payment

First, compute for the present value of the interest payment.

Annual interest = $2,960,000 * 10% = $296,000

{eq}PV~=~A~*~\frac{1(1~+~r)^-n)}{r}\\ Where:\\ A~=~annual~interest~payment\\ r~=~annual~interest~rate\\ n~=~number~of~periods {/eq}

{eq}PV~=~296,000~*~\frac{1(1~+~0.12)^-3)}{12} {/eq}

The present value of interest payment is $710,942

Next, compute the present value of the restructured loan.

{eq}PV~=~\frac{FV}{(1~+~r)^n}\\ Where:\\ FV~=~Restructured~loan~amount\\ r~=~annual~interest~rate\\ n~=~number~of~periods {/eq}

{eq}PV~=~\frac{2,960,000}{(1~+~0.12)^3} {/eq}

The present value of the principal loan is $2,106,870

Loss on restructuring = 3,700,000 - (2,106,870 + 710,942)

Loss on restructuring = $882,188

Accounts | Debit | Credit |
---|---|---|

Loss on Debt Restructuring | 882,188 | |

Loans Receivable | 882,188 |

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from Focus on Personal Finance: Online Textbook Help

Chapter 5 / Lesson 17