Exam 16: Financial Distress,managerial Incentives,and Information

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 $125 million face value due next year.The initial value of MI's debt is closest to:

Which of the following statements is FALSE?

Use the information for the question(s)below. If it is managed efficiently,Luther Industries will have assets with market value of $100 million,$300,million,or $500 million next year,with each outcome being equally likely.Managers may,however,engage in wasteful empire building which will reduce the firm's market value by $20 million in all cases.Managers may also increase the risk of the firm,changing the probability of each outcome to 50%,20%,and 30% respectively. -If its managers increase the risk of the firm,then the expected market value of Luther's assets is closest to:

In an agency problem known as debt overhang,if the company has risky debt outstanding,equity holders will choose to invest only if:

Use the information for the question(s)below. JR Industries has a $20 million loan due at the end of the year and under its current business strategy its assets will have a market value of only $15 million when the loan comes due.JR is considering a new much riskier business strategy.While this new riskier strategy can be implemented using JR's existing assets without any additional investment,the new strategy has only a 40% probability of succeeding.If the new strategy is a success,the market value of JR's assets will be $30 million,but if the strategy fails the assets will be worth only $5 million. -What is the overall expected payoff under JR's new riskier business strategy?

Which of the following statements is FALSE?

The cost of ________ is highest for firms that are likely to have profitable future growth opportunities requiring large investments.

The cost of ________ is highest for firms that can easily increase the risk of their investments.

Which of the following statements is FALSE?

The term moral hazard refers 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. -Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year.The yield to maturity of MI's debt is closest to:

Use the following information to answer the question(s)below. If managed effectively,Rearden Metal will have assets with a market value of $200 million,$300 million,or $400 million next year,with each outcome being equally likely.Managers,however,may decide to engage in wasteful empire building,which will reduce Rearden's market value by $20 million in all cases.Managers may also increase the risk of the firm,changing the probability of each outcome to 50%,5%,and 45% respectively. -What is the expected value of Rearden's assets if it were run efficiently?

Which of the following firms is likely to maintain low levels of debt?

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. -Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year.The present value of MI's financial distress costs is closest to:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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 $25 million in new debt,and you issue $25 million in new equity.Your ownership stake in the firm following these new issues of debt and equity is closest to:

In an agency problem known as asset substitution,the agency cost is paid by:

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. -Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs and 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.