Bankruptcy and defaulted on debts


Problem:

In the current year ( year 0), Amisha became a shareholder in Sultan Inc., a calendar year S corporation, by contributing $15,000 cash in exchange for stock. Shortly before the end of the year, Sultan's CFO notified Amisha that her pro rata share of ordinary loss for the year would be 55,000. Amisha immediately loaned $40,000 to Sultan in exchange for a two-year, interest-bearing corporate note. Consequently, she had enough stock and debt basis to allow her to deduct the $55,000 loss on her current year return.

Compute the NPV of Amish's cash flow associated with her loan in the following three cases. In each case, assume she has a 35 percent marginal tax rate on ordinary income, a 15 percent on capital gains, and uses a 6 percent discount rate.

1) For the next two years (year 1 and 2), Amisha share of Sultans ordinary income totaled $49,000, and sultan did not distribute any cash to its shareholders. However, it did repay the $40,000 loan plus $3,800 interest in year 2.

2) For the next two years (year 1 and year 2), Amisha share of Sultan ordinary income totaled $19,100, and Sultan did not distribute any cash of its shareholders. However, it did repay the $40,000 loan plus 3,800 interest year 2.

3) For the next two years (year 1 and year 2), Amisha share of Sultans ordinary loss totaled $11,400. In year 2, the corporation declared bankruptcy and defaulted on all its debts, including the loan from Amisha.

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Finance Basics: Bankruptcy and defaulted on debts
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