Exam 16: Financial Distress,managerial Incentives,and Information

Use the information for the question(s)below. Luther Industries has no debt and expects to generate free cash flows of $48 million each year.Luther believes that if it permanently increases its level of debt to $100 million,the risk of financial distress may cause it to lose some customers and receive less favorable terms from its suppliers.As a result,Luther's expected free cash flows with debt will be only $44 million per year.Suppose Luther's tax rate is 21%,the risk-free rate is 6%,the expected return of the market is 14%,and the beta of Luther's free cash flows is 1.25 (with or without leverage). -The value of Luther with leverage is closest to:

Use the information for the question(s)below. Electronic Gaming Incorporated (EGI)is a firm with no debt and its 20 million shares are currently trading for $16 per share.Based on the prospects for EGI's new handheld video game,management feels the true value of the firm is $20 per share.Management believes that the share price will reflect this higher value after the video game is released next fall.EGI has already announced plans to raise $100 million from investors to build a new factory. -Assume that EGI decides to wait until after the release of the new video game before they raise the $100 million through the issuance of new shares.The number of new shares that EGI will issue is closest to:

Use the information for the question(s)below. Monsters Incorporated (MI)is ready to launch a new product.Depending upon the success of this product,MI will have a value of either $100 million,$150 million,or $191 million,with each outcome being equally likely.The cash flows are unrelated to the state of the economy (i.e.risk from the project is diversifiable)so that the project has a beta of 0 and a cost of capital equal to the risk-free rate,which is currently 5%.Assume that the capital markets are perfect. -The initial value of MI's equity without leverage is closest to:

Use the information for the question(s)below. Electronic Gaming Incorporated (EGI)is a firm with no debt and its 20 million shares are currently trading for $16 per share.Based on the prospects for EGI's new handheld video game,management feels the true value of the firm is $20 per share.Management believes that the share price will reflect this higher value after the video game is released next fall.EGI has already announced plans to raise $100 million from investors to build a new factory. -Assume that EGI decides to wait until after the release of the new video game before they raise the $100 million through the issuance of new shares.EGI's share price following the release of the new video game will be closest to:

Which of the following statements is FALSE?

Use the information for the question(s)below. You own your own firm and you need to raise $50 million to fund an expansion.Following the expansion,your firm will be worth $75 million in its unlevered form.You want to go ahead with the expansion,but you are concerned that you may not be able to maintain ownership of over 50% of your firm's equity.In other words,you are concerned that if you use equity to finance the expansion,you may lose control of your firm. -Assume that capital markets are perfect,you issue $30 million in new debt,and you issue $20 million in new equity.Your ownership stake in the firm following these new issues of debt and equity is closest to:

Use the information for the question(s)below. Wildcat Drilling is an oil and gas exploration company that is currently operating two active oil fields with a market value of $200 million each.Unfortunately,Wildcat Drilling has $500 million in debt coming due at the end of the year.A large oil company has offered Wildcat drilling a highly speculative,but potentially very valuable,oil and gas lease in exchange for one of their active oil fields.If Wildcat accepts the trade,there is a 10% chance that Wildcat will discover a major new oil field that would be worth $1.2 billion,a 15% chance that Wildcat will discover a productive oil field that would be worth $600 million,and a 75% chance that Wildcat will not discover oil at all. -What is the overall expected payoff to Wildcat from the speculative oil lease deal?

Which of the following statements is FALSE?

Use the following information to answer the question(s)below. Nielson Motors has a debt-equity ratio of 1.8,an equity beta of 1.6,and a debt beta of 0.20.It is currently evaluating the following projects,none of which would change Nielson's volatility. (All amounts are in $millions. ) -In order for Nielson Motors to be willing to invest,project 5 must have an NPV greater than:

Use the information for the question(s)below. Monsters Incorporated (MI)is ready to launch a new product.Depending upon the success of this product,MI will have a value of either $100 million,$150 million,or $191 million,with each outcome being equally likely.The cash flows are unrelated to the state of the economy (i.e.risk from the project is diversifiable)so that the project has a beta of 0 and a cost of capital equal to the risk-free rate,which is currently 5%.Assume that the capital markets are perfect. -Assuming that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs,the initial value of MI's equity without leverage is closest to:

Which of the following industries is likely to have the lowest costs of financial distress?

Use the following information to answer the question(s)below. Nielson Motors has a debt-equity ratio of 1.8,an equity beta of 1.6,and a debt beta of 0.20.It is currently evaluating the following projects,none of which would change Nielson's volatility. (All amounts are in $millions. ) -The total debt overhang associated with accepting project 4 is closest to:

Use the information for the question(s)below. Wildcat Drilling is an oil and gas exploration company that is currently operating two active oil fields with a market value of $200 million each.Unfortunately,Wildcat Drilling has $500 million in debt coming due at the end of the year.A large oil company has offered Wildcat drilling a highly speculative,but potentially very valuable,oil and gas lease in exchange for one of their active oil fields.If Wildcat accepts the trade,there is a 10% chance that Wildcat will discover a major new oil field that would be worth $1.2 billion,a 15% chance that Wildcat will discover a productive oil field that would be worth $600 million,and a 75% chance that Wildcat will not discover oil at all. -What is the expected payoff to equity holders with the speculative oil lease deal?

Which of the following statements is FALSE?

Use the following information to answer the question(s)below. Nielson Motors has a debt-equity ratio of 1.8,an equity beta of 1.6,and a debt beta of 0.20.It is currently evaluating the following projects,none of which would change Nielson's volatility. (All amounts are in $millions. ) -Nielson Motors should accept those projects with profitability indices greater than:

Use the information for the question(s)below. Monsters Incorporated (MI)is ready to launch a new product.Depending upon the success of this product,MI will have a value of either $100 million,$150 million,or $191 million,with each outcome being equally likely.The cash flows are unrelated to the state of the economy (i.e.risk from the project is diversifiable)so that the project has a beta of 0 and a cost of capital equal to the risk-free rate,which is currently 5%.Assume that the capital markets are perfect. -Suppose that MI has zero-coupon debt with a $140 million face value due next year.Calculate the value of levered equity,the value of debt,and the total value of MI with leverage.

Which of the following is NOT an indirect cost of bankruptcy?

Which of the following statements is FALSE?

A type of agency problem that results in shareholders gaining by choosing not to finance new,positive-NPV projects is:

Which of the following statements is FALSE?