CIRA Principles & Practices 4 — Questions and Answers
Question 1: Which of the following is NOT a recognized test of insolvency under U.S. law?
- Balance sheet insolvency (liabilities exceed assets)
- Cash flow insolvency (inability to pay debts as they come due)
- Unreasonably small capital test
- Market capitalization insolvency (stock price below book value) (Correct answer)
Correct answer: Market capitalization insolvency (stock price below book value)
U.S. insolvency law recognizes three tests: balance sheet, cash flow, and unreasonably small capital; stock price relative to book value is not a legal insolvency test.
Question 2: In a liquidation analysis prepared for a Chapter 11 plan, what is the primary purpose?
- To project the company's future earnings post-reorganization
- To demonstrate that creditors receive at least as much as they would in a Chapter 7 liquidation (Correct answer)
- To calculate the debtor's tax attributes available after emergence
- To determine the appropriate interest rate on DIP financing
Correct answer: To demonstrate that creditors receive at least as much as they would in a Chapter 7 liquidation
The liquidation analysis satisfies the 'best interests of creditors' test under § 1129(a)(7), showing that each creditor receives at least a Chapter 7 liquidation recovery.
Question 3: A 'rights offering' in the context of a Chapter 11 plan of reorganization allows:
- Existing management to purchase assets free and clear
- Certain creditors to purchase new equity in the reorganized debtor at a discount (Correct answer)
- The DIP lender to convert its loan to equity at par
- The U.S. Trustee to issue new shares to administrative creditors
Correct answer: Certain creditors to purchase new equity in the reorganized debtor at a discount
A rights offering gives eligible creditors (often a backstopped class) the right to purchase newly issued equity in the reorganized company, often at a discount to estimated enterprise value.
Question 4: When a restructuring advisor prepares a going-concern valuation using discounted cash flow (DCF) analysis, the terminal value is most sensitive to changes in:
- The first-year EBITDA projection
- The weighted average cost of capital (WACC) and long-term growth rate (Correct answer)
- Accounts receivable days outstanding
- The number of years in the explicit forecast period
Correct answer: The weighted average cost of capital (WACC) and long-term growth rate
Terminal value, which typically represents the majority of DCF value, is highly sensitive to small changes in the discount rate (WACC) and the assumed perpetual growth rate.
Question 5: Under the CIRA Body of Knowledge, which concept describes a lender's right to receive proceeds from collateral before unsecured creditors?
- Equitable subordination
- Secured creditor priority (Correct answer)
- Administrative claim seniority
- Preference recovery right
Correct answer: Secured creditor priority
Secured creditors have a priority interest in their collateral, meaning they are paid from collateral proceeds before general unsecured creditors receive any distribution.
Question 6: What is 'substantive consolidation' in a multi-entity bankruptcy case?
- Merging all creditor committees into one body
- Treating the assets and liabilities of related debtors as if they were a single estate for distribution purposes (Correct answer)
- Converting all secured claims to unsecured claims
- Appointing a single trustee for all co-debtors
Correct answer: Treating the assets and liabilities of related debtors as if they were a single estate for distribution purposes
Substantive consolidation pools the assets and liabilities of affiliated debtors into one estate, affecting creditor recoveries based on the combined pool rather than individual entities.
Question 7: Which of the following best defines 'net present value' (NPV) as used in restructuring valuations?
- The sum of undiscounted future cash flows minus current liabilities
- The present value of expected future cash flows discounted at the appropriate risk-adjusted rate (Correct answer)
- Total assets minus intangible assets and goodwill
- The market price of a company's debt divided by its book equity
Correct answer: The present value of expected future cash flows discounted at the appropriate risk-adjusted rate
NPV is the sum of future cash flows, each discounted back to today using a rate that reflects the time value of money and investment risk.
CIRA Principles & Practices 4
Which of the following is NOT a recognized test of insolvency under U.S. law?