Question 1

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

Accepted Answer

A) Airlines 
B) Computer software 
C) Biotechnology 
D) Electric utilities 
A) Airlines 
B) Computer software 
C) Biotechnology 
D) Electric utilities

Question 2

Which of the following statements is FALSE?

Accepted Answer

A) An important consequence of leverage is the risk of bankruptcy. 
B) Whether default occurs depends on the cash flows,not on the relative values of the firm's assets and liabilities. 
C) Economic distress is a significant decline in the value of a firm's assets,whether or not it experiences financial distress due to leverage. 
D) Modigliani and Miller's results continue to hold in a perfect market even when debt is risky and the firm may default. 
A) An important consequence of leverage is the risk of bankruptcy. 
B) Whether default occurs depends on the cash flows,not on the relative values of the firm's assets and liabilities. 
C) Economic distress is a significant decline in the value of a firm's assets,whether or not it experiences financial distress due to leverage. 
D) Modigliani and Miller's results continue to hold in a perfect market even when debt is risky and the firm may default.

Question 3

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 hand held 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.The number of new shares that EGI will issue is closest to:

Accepted Answer

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

Question 4

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) $133 million 
B) $140 million 
C) $147 million 
D) $125 million 
A) $133 million 
B) $140 million 
C) $147 million 
D) $125 million

Question 5

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 6

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:

Accepted Answer

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

Question 7

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

Accepted Answer

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

Question 8

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 9

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 $30 million in new debt,and you issue $20 million in new equity.You ownership stake in the firm following these new issues of debt and equity is closest to:

Accepted Answer

A) 58% 
B) 50% 
C) 33% 
D) 55% 
A) 58% 
B) 50% 
C) 33% 
D) 55%

Question 10

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 11

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

Accepted Answer

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

Question 12

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:

Accepted Answer

A) 50% 
B) 55% 
C) 58% 
D) 33% 
A) 50% 
B) 55% 
C) 58% 
D) 33%

Question 13

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 14

Which of the following statements is FALSE?

Accepted Answer

A) Firms with steady,reliable cash flows,such as utility companies,are able to use high levels of debt and still have a very low probability of default. 
B) If there were no costs of financial distress,the value of the firm would continue to increase with increasing debt until the interest on the debt exceeds the firm's earnings before interest and taxes and the tax shield is exhausted. 
C) The costs of financial distress reduce the value of the levered firm,VL.The amount of the reduction decreases with the probability of default,which in turn increases with the level of the debt D. 
D) The tradeoff theory states that firms should increase their leverage until it reaches the level D* for which VL is maximized. 
A) Firms with steady,reliable cash flows,such as utility companies,are able to use high levels of debt and still have a very low probability of default. 
B) If there were no costs of financial distress,the value of the firm would continue to increase with increasing debt until the interest on the debt exceeds the firm's earnings before interest and taxes and the tax shield is exhausted. 
C) The costs of financial distress reduce the value of the levered firm,VL.The amount of the reduction decreases with the probability of default,which in turn increases with the level of the debt D. 
D) The tradeoff theory states that firms should increase their leverage until it reaches the level D* for which VL is maximized.

Question 15

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

Accepted Answer

A) Legal fees 
B) Delayed liquidation 
C) Costs to creditors 
D) Loss of customers 
A) Legal fees 
B) Delayed liquidation 
C) Costs to creditors 
D) Loss of customers

Question 16

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 17

Which of the following statements is FALSE?

Accepted Answer

A) The tradeoff theory weighs the costs of debt that result from shielding cash flows from taxes against the benefits from the effects of financial distress associated with leverage. 
B) Leverage has costs as well as benefits. 
C) According to the tradeoff theory,the total value of a levered firm equals the value of the firm without leverage plus the present value of the tax savings from debt,less the present value of financial distress costs. 
D) Firms have an incentive to increase leverage to exploit the tax benefits of debt.But with too much debt,they are more likely to risk default and incur financial distress costs. 
A) The tradeoff theory weighs the costs of debt that result from shielding cash flows from taxes against the benefits from the effects of financial distress associated with leverage. 
B) Leverage has costs as well as benefits. 
C) According to the tradeoff theory,the total value of a levered firm equals the value of the firm without leverage plus the present value of the tax savings from debt,less the present value of financial distress costs. 
D) Firms have an incentive to increase leverage to exploit the tax benefits of debt.But with too much debt,they are more likely to risk default and incur financial distress costs.

Question 18

Which of the following statements is FALSE?

Accepted Answer

A) The most important insight regarding capital structure goes back to Modigliani and Miller: With perfect capital markets,a firm's security choice alters the risk of the firm's equity,but it does not change its value or the amount it can raise from outside investors. 
B) When agency costs are significant,short-term debt may be the most attractive form of external financing. 
C) Too much debt can motivate managers and equity holders to take excessive risks or over-invest in a firm. 
D) Of all the different possible imperfections that drive capital structure,the most clear-cut,and possibly the most significant,is taxes. 
A) The most important insight regarding capital structure goes back to Modigliani and Miller: With perfect capital markets,a firm's security choice alters the risk of the firm's equity,but it does not change its value or the amount it can raise from outside investors. 
B) When agency costs are significant,short-term debt may be the most attractive form of external financing. 
C) Too much debt can motivate managers and equity holders to take excessive risks or over-invest in a firm. 
D) Of all the different possible imperfections that drive capital structure,the most clear-cut,and possibly the most significant,is taxes.

Question 19

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:

Accepted Answer

A) $25 million 
B) $50 million 
C) $60 million 
D) $70 million 
A) $25 million 
B) $50 million 
C) $60 million 
D) $70 million

Question 20

In order for Nielson Motor's to be willing to invest,project 3 must have an NPV greater than:

Accepted Answer

A) $12.5 million 
B) $15.0 million 
C) $22.5 million 
D) $27.0 million 
A) $12.5 million 
B) $15.0 million 
C) $22.5 million 
D) $27.0 million

Exam 16: Financial Distress,managerial Incentives,and Information

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

Which of the following statements is FALSE?

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:

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:

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

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:

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:

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

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:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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

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:

Which of the following statements is FALSE?

Which of the following statements is FALSE?

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:

In order for Nielson Motor's to be willing to invest,project 3 must have an NPV greater than:

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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