Exam 16: Financial Distress,managerial Incentives,and Information

The idea that when a seller has private information about the value of goods,buyers will discount the price they are willing to pay due to adverse selection is known as the:

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 $5 million,then the optimal level of debt for d'Anconia Copper is:

Which of the following is one unintended consequence of the federal bailouts in response to the 2008 financial crisis?

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

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 equity holders under JR's new riskier business strategy?

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 $230 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. -If you take the job with Wyatt Oil,then,in the event of bankruptcy,the least amount that Wyatt Oil would pay you next year is closest to:

Which of the following statements is FALSE?

A type of agency problem that results in shareholders gaining from decisions that increase the risk of the firm sufficiently,even if they have negative NPV is:

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.Your firm pays 21% of earnings in taxes and you decide to issue $25 million in new debt and $25 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. 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 initial value of MI's debt is closest to: