Exam 19: Financial Distress, managerial Incentives, and Information

Use the information for the question(s) below. Luther Industries has no debt and expects to generate free cash flows of $48 million each year. Luther believes that if it permanently increases its level of debt to $100 million, the risk of financial distress may cause it to lose some customers and receive less favourable terms from its suppliers. As a result, Luther's expected free cash flows with debt will be only $44 million per year. Suppose Luther's tax rate is 40%, the risk-free rate is 6%, the expected return of the market is 14%, and the beta of Luther's free cash flows is 1.25 (with or without leverage). -The value of Luther with leverage is closest to:

Which of the following statements is false?

When Air Canada was in the process of reorganizing under the CCAA in 2003-2004,it was able to win wage concessions from its powerful unions by explaining that ________,if continued,would push Air Canada into bankruptcy.

The BIA usually applies to ________ while the CCAA applies to firms that owe ________ to creditors.

The tradeoff theory weighs ________ of debt that result from shielding cash flows from taxes against the costs of financial distress associated with leverage.

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.EGI's share price following the release of the new video game will be closest to:

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

As the case of Air Canada demonstrates,firms such as airlines whose future cash flows are unstable and highly sensitive to shocks in the economy run the risk of bankruptcy if they use ________ leverage.

There are two relevant acts for financially distressed firms in Canada:

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. -Suppose that MI has zero-coupon debt with a $140 million face value due next year.Calculate the value of levered equity,the value of debt,and the total value of MI with leverage.

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. -The number of new shares that Kinston must issue to raise the capital needed to pay its debt obligation 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.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:

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 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:

An over-investment problem means that shareholders have an incentive to invest in risky ________ projects.

An under-investment problem suggests that shareholders choose to not invest in a ________ project.

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. -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. 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.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 $10.85 per share following the announcement,then the present value of BBB's financial distress costs is closest to:

Which of the following statements is false?

Which of the following statements is false?

Which of the following statements is false?