Exam 19: Financial Distress, managerial Incentives, and Information

Use the information for the question(s) below. If it is managed efficiently, Luther Industries will have assets with a market value of $100 million, $300, million, or $500 million next year, with each outcome being equally likely. Managers may, instead, 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 it is managed efficiently,then the expected market value of Luther's assets is closest to:

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

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:

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 $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?

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. -The initial value of MI's equity without leverage is closest to:

Which of the following statements is false?

Which of the following statements is false?

In Canadian Corporations,more than 60% of capital expenditures are funded from ________.

The idea that managers who perceive the firm's equity is under-priced 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. 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 equity is closest to:

Use the information for the question(s) below. Wildcat Drilling is an oil and gas exploration company that is currently operating two active oil fields with a market value of $200 million dollars each. Unfortunately, Wildcat Drilling has $500 million in debt coming due at the end of the year. A large oil company has offered Wildcat drilling a highly speculative, but potentially very valuable, oil and gas lease in exchange for one of their active oil fields. If Wildcat accepts the trade, there is a 10% chance that Wildcat will discover a major new oil field that would be worth $1.2 billion, a 15% chance that Wildcat will discover a productive oil field that would be worth $600 million, and a 75% chance that Wildcat will not discover any oil at all. -What is the expected payoff to equity holders with the speculative oil lease deal?

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 40% of earnings in taxes.If you want to maintain ownership of at least 50% of your firm,then the minimum amount of debt that you must issue to fund the expansion is closest to:

Use the information for the question(s) below. If it is managed efficiently, Luther Industries will have assets with a market value of $100 million, $300, million, or $500 million next year, with each outcome being equally likely. Managers may, instead, 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 increase the risk of the firm,then the expected market value of Luther's assets is closest to:

Banks are generally opposed to high capital requirements. Moral hazard may partially explain why because

Which of the following firms is likely to maintain low levels of debt?

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 35% 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:

Two key qualitative factors determine ________ of financial distress costs: (1)the probability of financial distress and (2)the magnitude of the costs after a firm is in distress.

Use the information for the question(s) below. Kinston Enterprises has no debt and a debt obligation of $47 million that is due now. The market value of Kinston's assets is $102 million, and the firm has no other liabilities. Assume that capital markets are perfect and that Kinston has 5 million shares outstanding. -Kinston's current share price is closest to:

Which of the following statements is false?