Question 1

What is the expected payoff to equity holders under JR's new riskier business strategy?

Accepted Answer

A) $15 million 
B) $11 million 
C) $20 million 
D) $4 million 
A) $15 million 
B) $11 million 
C) $20 million 
D) $4 million

Question 2

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

Accepted Answer

A) the debt holders,since if the risky project is not successful debt holders will lose all their money. 
B) the debt holders,since if the risky project is successful debt holders will receive less money. 
C) the equity holders,since the strategy has a negative expected payoff. 
D) the equity holders,since they will lose all their money whether or not the project is successful. 
A) the debt holders,since if the risky project is not successful debt holders will lose all their money. 
B) the debt holders,since if the risky project is successful debt holders will receive less money. 
C) the equity holders,since the strategy has a negative expected payoff. 
D) the equity holders,since they will lose all their money whether or not the project is successful.

Question 3

If Nielson Motors invests in only those projects which are beneficial to the stockholders,then the total debt overhang associated with accepting these project(s)is closest to:

Accepted Answer

A) $22.5 million 
B) $36.0 million 
C) $38.0 million 
D) $57.5 million 
A) $22.5 million 
B) $36.0 million 
C) $38.0 million 
D) $57.5 million

Question 4

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 ratios greater than:

Accepted Answer

A) 0.15 
B) 0.175 
C) 0.20 
D) 0.225 
A) 0.15 
B) 0.175 
C) 0.20 
D) 0.225

Question 5

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:

Accepted Answer

A) asset substitution. 
B) debt overhang. 
C) underinvestment. 
D) cashing out. 
A) asset substitution. 
B) debt overhang. 
C) underinvestment. 
D) cashing out.

Question 6

The value of Luther with leverage is closest to:

Accepted Answer

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

Question 7

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:

Accepted Answer

A) $110 million 
B) $105 million 
C) $125 million 
D) $111 million 
A) $110 million 
B) $105 million 
C) $125 million 
D) $111 million

Question 8

If its managers increase the risk of the firm,then the expected market value of Luther's assets is closest to:

Accepted Answer

A) $260 
B) $240 
C) $300 million 
D) $280 million 
A) $260 
B) $240 
C) $300 million 
D) $280 million

Question 9

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

Accepted Answer

A) $20 million 
B) $4 million 
C) $15 million 
D) $11 million 
A) $20 million 
B) $4 million 
C) $15 million 
D) $11 million

Question 10

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 decided 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?

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 11

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 12

What is the expected payoff to debt holders with the speculative oil lease deal?

Accepted Answer

A) $10 million 
B) $275 million 
C) $85 million 
D) $160 million 
A) $10 million 
B) $275 million 
C) $85 million 
D) $160 million

Question 13

Which of the following statements is FALSE?

Accepted Answer

A) Leverage can reduce the degree of managerial entrenchment because managers are more likely to be fired when a firm faces financial distress. 
B) When a firm is highly levered,creditors themselves will closely monitor the actions of managers,providing an additional layer of management oversight. 
C) According to the empire building hypothesis,leverage increases firm value because it commits the firm to making future interest payments,thereby reducing excess cash flows and wasteful investment by managers. 
D) Managers of large firms tend to earn higher salaries,and they may also have more prestige and garner greater publicity than managers of small firms.As a result,managers may expand (or fail to shut down)unprofitable divisions,pay too much for acquisitions,make unnecessary capital expenditures,or hire unnecessary employees. 
A) Leverage can reduce the degree of managerial entrenchment because managers are more likely to be fired when a firm faces financial distress. 
B) When a firm is highly levered,creditors themselves will closely monitor the actions of managers,providing an additional layer of management oversight. 
C) According to the empire building hypothesis,leverage increases firm value because it commits the firm to making future interest payments,thereby reducing excess cash flows and wasteful investment by managers. 
D) Managers of large firms tend to earn higher salaries,and they may also have more prestige and garner greater publicity than managers of small firms.As a result,managers may expand (or fail to shut down)unprofitable divisions,pay too much for acquisitions,make unnecessary capital expenditures,or hire unnecessary employees.

Question 14

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 40% and that shareholders expects 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 $10.80 per share following the announcement,then the present value of BBB's financial distress costs is closest to:

Accepted Answer

V^U = $10.00 × 25 million shares = $250 mi

Question 15

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

Accepted Answer

A) $260 
B) $280 million 
C) $240 
D) $300 million 
A) $260 
B) $280 million 
C) $240 
D) $300 million

Question 16

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:

Accepted Answer

A) 1.6 million 
B) 5.0 million 
C) 10 million 
D) 6.25 million 
A) 1.6 million 
B) 5.0 million 
C) 10 million 
D) 6.25 million

Question 17

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:

Accepted Answer

A) $280 million 
B) $295 million 
C) $300 million 
D) $900 million 
A) $280 million 
B) $295 million 
C) $300 million 
D) $900 million

Question 18

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:

Accepted Answer

A) pecking order hypothesis. 
B) credibility principle. 
C) lemons principle. 
D) signaling theory of debt. 
A) pecking order hypothesis. 
B) credibility principle. 
C) lemons principle. 
D) signaling theory of debt.

Question 19

Which of the following statements is FALSE?

Accepted Answer

A) Calculating the precise present value of financial distress costs is a relatively straightforward process. 
B) Two key qualitative factors determine the present value of financial distress costs: (1)the probability of financial distress and (2)the magnitude of the costs after a firm is in distress. 
C) Technology firms are likely to incur high costs when they are in financial distress,due to the potential for loss of customers and key personnel,as well as a lack of tangible assets that can be easily liquidated. 
D) The magnitude of the financial distress costs will depend on the relative importance of the sources of these costs and is likely to vary by industry. 
A) Calculating the precise present value of financial distress costs is a relatively straightforward process. 
B) Two key qualitative factors determine the present value of financial distress costs: (1)the probability of financial distress and (2)the magnitude of the costs after a firm is in distress. 
C) Technology firms are likely to incur high costs when they are in financial distress,due to the potential for loss of customers and key personnel,as well as a lack of tangible assets that can be easily liquidated. 
D) The magnitude of the financial distress costs will depend on the relative importance of the sources of these costs and is likely to vary by industry.

Question 20

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

Accepted Answer

A) Loss of suppliers 
B) Fire sales of assets 
C) Costs of appraisers 
D) Loss of employees 
A) Loss of suppliers 
B) Fire sales of assets 
C) Costs of appraisers 
D) Loss of employees

Exam 16: Financial Distress,managerial Incentives,and Information

What is the expected payoff to equity holders under JR's new riskier business strategy?

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

If Nielson Motors invests in only those projects which are beneficial to the stockholders,then the total debt overhang associated with accepting these project(s)is closest to:

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:

The value of Luther with leverage is closest to:

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:

If its managers increase the risk of the firm,then the expected market value of Luther's assets is closest to:

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

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:

What is the expected payoff to debt holders with the speculative oil lease deal?

Which of the following statements is FALSE?

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

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:

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:

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:

Which of the following statements is FALSE?

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

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

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