Question 1

Which of the following influences a firm's choice of capital structure?

Accepted Answer

A) Taxes 
B) Agency costs and benefits of leverage 
C) Signaling and adverse selection 
D) All of the above influence capital structure decisions. 
A) Taxes 
B) Agency costs and benefits of leverage 
C) Signaling and adverse selection 
D) All of the above influence capital structure decisions.

Question 2

Rose Industries has a $20 million loan due at the end of the year and its assets will have a market value of only $15 million when the loan comes due.Currently Rose has $2 million in cash.Rose is considering two possible alternative uses for this cash.One possibility is to pay the $2 million out to shareholders in the form of a special dividend.The second possibility is to invest the $2 million into a project that offers a $4 million NPV.What are the payoffs to the debt and equity holders under each of the two alternatives? Which alternative would equity holders prefer? Which alternative would debt holders prefer? What is the economic term that describes this situation?

Accepted Answer

Case #1 Pay special dividend
Payoff to e

Question 3

Which of the following agency problems represents a form of moral hazard?

Accepted Answer

A) asset substitution 
B) debt overhang 
C) cashing out 
D) All of the above are examples of moral hazard. 
A) asset substitution 
B) debt overhang 
C) cashing out 
D) All of the above are examples of moral hazard.

Question 4

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.Suppose that at the start of the year,MI has no debt outstanding,but has 5.6 million shares of stock outstanding.If MI does not issue debt,its share price is closest to:

Accepted Answer

A) $5.15. 
B) $23.75. 
C) $23.90. 
D) $25.00. 
A) $5.15. 
B) $23.75. 
C) $23.90. 
D) $25.00.

Question 5

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 expected return of MI's debt is closest to:

Accepted Answer

A) 25.0%. 
B) 12.5%. 
C) 5.0%. 
D) 7.8%. 
A) 25.0%. 
B) 12.5%. 
C) 5.0%. 
D) 7.8%.

Question 6

Use the information for the question(s)below.
Big Blue Banana (BBB)is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding.Suppose that Big Blue Banana announces plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.
-Assuming perfect capital markets,the share price for BBB after this announcement is closest to:

Accepted Answer

A) $11.40. 
B) $10.85. 
C) $10.00. 
D) $8.60. 
A) $11.40. 
B) $10.85. 
C) $10.00. 
D) $8.60.

Question 7

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.
-Suppose that the managers at Rearden Metal will engage in empire building unless that behavior increases the likelihood of bankruptcy.If Rearden has $190 million in debt due in one year,then the expected value of Rearden's assets is closest to:

Accepted Answer

A) $265 million. 
B) $280 million. 
C) $295 million. 
D) $300 million. 
A) $265 million. 
B) $280 million. 
C) $295 million. 
D) $300 million.

Question 8

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 equity is closest to:

Accepted Answer

A) $30 million. 
B) $15 million. 
C) $29 million. 
D) $24 million. 
A) $30 million. 
B) $15 million. 
C) $29 million. 
D) $24 million.

Question 9

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 without leverage is closest to:

Accepted Answer

A) $315 million. 
B) $300 million. 
C) $205 million. 
D) $340 million. 
A) $315 million. 
B) $300 million. 
C) $205 million. 
D) $340 million.

Question 10

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 except for the existence of corporate taxes and that your firm pays 21% of earnings in taxes.If you want to maintain ownership of at least 50%,then the minimum amount of debt that you must issue to fund the expansion is closest to:

Accepted Answer

A) $19 million. 
B) $14 million. 
C) $16 million. 
D) $20 million. 
A) $19 million. 
B) $14 million. 
C) $16 million. 
D) $20 million.

Question 11

Use the following information to answer the question(s)below.
d'Anconia Copper is considering issuing one-year debt,and has come up with the following estimates of the value of the interest tax shield and the probability of distress for different levels of debt:  
-If in the event of distress,the present value of distress costs is equal to $25 million,then the optimal level of debt for d'Anconia Copper is:

Accepted Answer

A) $50 million. 
B) $60 million. 
C) $70 million. 
D) $80 million. 
A) $50 million. 
B) $60 million. 
C) $70 million. 
D) $80 million.

Question 12

Which of the following statements is FALSE?

Accepted Answer

A) Although indirect costs of bankruptcy are difficult to measure accurately,they are typically much smaller than the direct costs of bankruptcy. 
B) Bankruptcy protection can be used by management to delay the liquidation of a firm that should be shut down. 
C) Because many aspects of the bankruptcy process are independent of the size of the firm,the costs are typically higher,in percentage terms,for smaller firms. 
D) Aside from the direct legal and administrative costs of bankruptcy,many other indirect costs are associated with financial distress (whether or not the firm has formally filed for bankruptcy). 
A) Although indirect costs of bankruptcy are difficult to measure accurately,they are typically much smaller than the direct costs of bankruptcy. 
B) Bankruptcy protection can be used by management to delay the liquidation of a firm that should be shut down. 
C) Because many aspects of the bankruptcy process are independent of the size of the firm,the costs are typically higher,in percentage terms,for smaller firms. 
D) Aside from the direct legal and administrative costs of bankruptcy,many other indirect costs are associated with financial distress (whether or not the firm has formally filed for bankruptcy).

Question 13

Which of the following statements is FALSE?

Accepted Answer

A) Equity holders expect to receive dividends and the firm is legally obligated to pay them. 
B) A firm that fails to make the required interest or principal payments on the debt is in default. 
C) In the extreme case,the debt holders take legal ownership of the firm's assets through a process called bankruptcy. 
D) After a firm defaults,debt holders are given certain rights to the assets of the firm. 
A) Equity holders expect to receive dividends and the firm is legally obligated to pay them. 
B) A firm that fails to make the required interest or principal payments on the debt is in default. 
C) In the extreme case,the debt holders take legal ownership of the firm's assets through a process called bankruptcy. 
D) After a firm defaults,debt holders are given certain rights to the assets of the firm.

Question 14

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 1 is closest to:

Accepted Answer

A) $0 million. 
B) $12.5 million. 
C) $14.4 million. 
D) $22.5 million. 
A) $0 million. 
B) $12.5 million. 
C) $14.4 million. 
D) $22.5 million.

Question 15

Which of the following statements is FALSE?

Accepted Answer

A) The U.S.bankruptcy code was created to organize this process so that creditors are treated fairly and the value of the assets is not needlessly destroyed. 
B) Because the assets of the firm might be more valuable if kept together,creditors seizing assets in a piecemeal fashion might destroy much of the remaining value of the firm. 
C) Debt holders can then take legal action against the firm to collect payment by seizing the firm's assets. 
D) Because most firms have multiple creditors,coordination makes it difficult to guarantee that each creditor will be treated fairly. 
A) The U.S.bankruptcy code was created to organize this process so that creditors are treated fairly and the value of the assets is not needlessly destroyed. 
B) Because the assets of the firm might be more valuable if kept together,creditors seizing assets in a piecemeal fashion might destroy much of the remaining value of the firm. 
C) Debt holders can then take legal action against the firm to collect payment by seizing the firm's assets. 
D) Because most firms have multiple creditors,coordination makes it difficult to guarantee that each creditor will be treated fairly.

Question 16

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 total value of MI with leverage is closest to:

Accepted Answer

A) $140 million. 
B) $100 million. 
C) $125 million. 
D) $134 million. 
A) $140 million. 
B) $100 million. 
C) $125 million. 
D) $134 million.

Question 17

Which of the following is NOT a direct cost of bankruptcy?

Accepted Answer

A) Costs to creditors 
B) Investment banking costs 
C) Costs of accounting experts 
D) Legal costs and fees 
A) Costs to creditors 
B) Investment banking costs 
C) Costs of accounting experts 
D) Legal costs and fees

Question 18

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.
-Suppose that the managers at Rearden Metal will engage in empire building unless that behavior increases the likelihood of bankruptcy.If Rearden has $180 million in debt due in one year,then the expected value of Rearden's assets is closest to:

Accepted Answer

A) $265 million. 
B) $280 million. 
C) $295 million. 
D) $300 million. 
A) $265 million. 
B) $280 million. 
C) $295 million. 
D) $300 million.

Question 19

Which of the following statements is FALSE?

Accepted Answer

A) Real estate firms are likely to have low costs of financial distress,as much of their value derives from assets that can be sold relatively easily. 
B) For low levels of debt,the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield,which has present value τ*D,where τ* is the effective tax advantage of debt. 
C) Firms whose value and cash flows are very volatile (for example,semiconductor firms)must have much higher levels of debt to avoid a significant risk of default. 
D) The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default. 
A) Real estate firms are likely to have low costs of financial distress,as much of their value derives from assets that can be sold relatively easily. 
B) For low levels of debt,the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield,which has present value τ*D,where τ* is the effective tax advantage of debt. 
C) Firms whose value and cash flows are very volatile (for example,semiconductor firms)must have much higher levels of debt to avoid a significant risk of default. 
D) The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.

Question 20

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 except for the existence of corporate taxes and that your firm pays 35% of earnings in taxes.If you want to maintain ownership of at least 50%,then calculate the minimum amount of debt that you must issue to fund the expansion.

Accepted Answer

VU = $75 million
% Ownership = @#IMG-DLM& Given:
V

Which of the following influences a firm's choice of capital structure?

Which of the following agency problems represents a form of moral hazard?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following is NOT a direct cost of bankruptcy?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters

Exam 16: Financial Distress,managerial Incentives,and Information

Which of the following influences a firm's choice of capital structure?

Which of the following agency problems represents a form of moral hazard?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following statements is FALSE?

Which of the following is NOT a direct cost of bankruptcy?

Which of the following statements is FALSE?

The Corporation

Introduction to Financial Statement Analysis

Financial Decision Making and the Law of One Price

The Time Value of Money

Interest Rates

Valuing Bonds

Investment Decision Rules

Fundamentals of Capital Budgeting

Valuing Stocks

Capital Markets and the Pricing of Risk

Optimal Portfolio Choice and the Capital Asset Pricing Model

Estimating the Cost of Capital

Investor Behavior and Capital Market Efficiency

Capital Structure in a Perfect Market

Debt and Taxes

Payout Policy

Capital Budgeting and Valuation With Leverage

Valuation and Financial Modeling: a Case Study

Financial Options

Option Valuation

Real Options

Raising Equity Capital

Debt Financing

Leasing

Working Capital Management

Short-Term Financial Planning

Mergers and Acquisitions

Corporate Governance

Risk Management

International Corporate Finance

Filters