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. -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 issues debt of $125 million due next year and uses the proceeds to repurchase shares,the share price following the announcement of the repurchase will be closest to:

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 expected payoff to debt holders under JR's new riskier business strategy?

The idea that managers who perceive the firm's equity is underpriced will have a preference to fund investment using retained earnings,or debt,rather than equity is known as the:

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 raise the $100 million through the issuance of new shares prior to the release of the new video game.EGI's share price following the release of the new video game will be closest to:

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. -Suppose that BBB pays corporate taxes of 21% and that shareholders expect the change in debt to be permanent.Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs.If the price of BBB's stock rises to $10.29 per share following the announcement,then the present value of BBB's financial distress costs is closest to:

Use the following information to answer the question(s)below. Suppose that you have received two job offers.Rearden Metal offers you a contract for $75,000 per year for the next two years while Wyatt Oil offers you a contract for $90,000 per year for the next two years.Both jobs are equivalent.Suppose that Rearden Metal's contract is certain,but Wyatt Oil has a 60% chance of going bankrupt at the end of the year.In the event that Wyatt Oil files for bankruptcy,it will cancel your contract and pay you the lowest amount possible for you to not quit.If you do quit,you expect you could find a new job paying $75,000 per year,but you would be unemployed for four months while searching for this new job. -Assuming your cost of capital is 6 percent,the present value of your expected wage if you accept Wyatt Oil's offer is closest to:

Which of the following statements is FALSE?

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 engage in empire building,then the expected market value of Luther's assets is closest to:

Because debtor-in-possession (DIP)financing is senior to all existing creditors:

Which of the following is unlikely to influence a firm's choice of capital structure?

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 3 must have an NPV greater than:

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. -Suppose that BBB pays corporate taxes of 21% and that shareholders expect the change in debt to be permanent.Assuming that capital markets are perfect except for the existence of corporate taxes,the share price for BBB after this announcement is closest to:

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. ) -Which of the following projects should Nielson Motors accept?

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 increase risk to maximize the expected payoff to equity holders.If Rearden has $180 million in debt due in one year,then the expected value of Rearden's assets is closest to:

Use the following information to answer the question(s)below. Suppose that you have received two job offers.Rearden Metal offers you a contract for $75,000 per year for the next two years while Wyatt Oil offers you a contract for $90,000 per year for the next two years.Both jobs are equivalent.Suppose that Rearden Metal's contract is certain,but Wyatt Oil has a 60% chance of going bankrupt at the end of the year.In the event that Wyatt Oil files for bankruptcy,it will cancel your contract and pay you the lowest amount possible for you to not quit.If you do quit,you expect you could find a new job paying $75,000 per year,but you would be unemployed for four months while searching for this new job. -Assuming your cost of capital is 6 percent,based on the present value of your expected wage you should:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

The idea that claims in one's self-interest are credible only if they are supported by actions that would be too costly to take if the claims were untrue is known as the:

List five general categories of indirect costs associated with bankruptcy.