finance chapter 13

Which of the following are examples of firms which filed for bankruptcy for strategic reasons? - Texaco - Northwest Airline - Johns Manville - Dow Corning - Continental Airlines

- Texaco - Johns Manville - Dow Corning - Continental Airlines

Which of the following describe a firm that takes advantage of a reorganization? - The business must have its reorganization approved by its creditors. - It is allowed to issue new securities. - The firm continues to operate. - It must liquidate its assets and end its operations.

- The business must have its reorganization approved by its creditors. - It is allowed to issue new securities. - The firm continues to operate.

Which of the following industries tend to have a high leverage? - airlines - restaurants - computers - drugs

- airlines - restaurants

A capital restructuring may include:

- issuing more equity - issuing debt and repurchasing equity - issuing more debt

How does the level of debt affect the weighted average cost of capital (WACC)?

The WACC initially falls and then rises as debt increases.

Which of the following is true of the impact of financial leverage? a) It magnifies gains and losses. b) It protects gains and minimizes losses. c) It magnifies gains but protects against losses. d) It protects gains but magnifies losses.

a) It magnifies gains and losses.

The costs of financial distress depend mostly on how easily the ownership of the firm's _______ can be transferred.

assets

Which of the following statements are true regarding the effect of financial leverage and the firm's operating earnings (EBIT)? a) Below the EBIT break-even point, the levered capital structure is best. b) Financial leverage decreases the slope of the EPS line. c) The rate of return on assets is unaffected by leverage. The slope of the EPS line is unaffected by financial leverage.

c) The rate of return on assets is unaffected by leverage.

Bankruptcy costs may exceed the tax shield benefits of ________

debt

Which two of the following are broad types of costs of financial distress?

direct and indirect costs

Which costs of financial distress are easier to measure?

direct costs

The optimal level of debt in the presence of corporate taxes and bankruptcy costs occurs at the point at which the present value of distress costs (maximizes/minimizes/equals)

equals

The tax deductibility of interest payments is (good/bad/has no effect on) the firm

good

The value of a levered firm will be __________ than the value of an identical unlevered firm because the levered firm's taxes will be ________

greater; lower

If the degree of leverage increases, the cost of debt will ________

increase

The static theory of capital structure suggests employing debt to the point that its cost equals the cost of _____

increased probability of bankruptcy

The cost of debt will begin to increase as the degree of leverage (increases/decreases)

increases

Capital structure decisions are made (after/taking into account/independent of/in conjunction with) investment decisions

independent of

Customers refusing to buy GM cars when it filed for Chapter 11 for fear of not being able to service the cars in the future is an example of ______ costs of financial distress.

indirect

Which of the two types of costs of bankruptcy are more difficult to quantify?

indirect costs

The idea that a firm borrows to the point that the tax benefit of debt is exactly equal to the increased probability of financial distress is called the ________ theory of capital structure.

static

It is often in everyone's best interest to devise a "workout" strategy that avoids bankruptcy because:

the bankruptcy process can be long and expensive

A firm's capital structure refers to ______

the firm's mix of debt and equity

True or false: According to the absolute priority rule, administrative expenses associated with the bankruptcy are paid first in the distribution of the proceeds of liquidation.

true

true or false: Firm value is maximized when the WACC is minimized.

true

True or false: It is possible for the present value of distress costs to exceed the present value of tax savings.

true: the PV of distress costs can exceed the present value of tax savings at very high levels of debt.

A firm is considered bankrupt when the value of its equity is _______

zero

Which of the following are direct costs of financial distress? - loss of key employees - loss of asset value - lost sales - legal fees - administrative expenses

- legal fees - administrative expenses

The tax shield afforded by debt will be of the least use to firms with _______ - high levels of debt - losses carried forward - negative EBT - high N.I

- losses carried forward - negative EBT

What are some examples of indirect financial distress costs? - lost reputation - lost sales - lost dividends - legal expenses

- lost reputation - lost sales

An optimal capital structure will _______

- maximize the value of the firm - minimize the cost of capital

Bankruptcy is very valuable because:

- payments to creditors cease pending the outcome of the bankruptcy process - it can be used strategically to improve a firm's competitive position

True or false: The legal process of bankruptcy is typically quick and inexpensive.

false

The risk of too much __________ is bankruptcy.

leverage

Liquidation differs from reorganization in that:

liquidation terminates business activity while reorganization allows the firm to continue operating

Which of the following will apply when a firm's debt levels are extremely high? - The possibility of financial distress will become a chronic problem. - The benefits of debt financing may be more than offset by the costs of financial distress. - The value of the firm will grow exponentially as debt levels continue to increase. - The costs of financial distress may be more than offset by the benefits of debt financing.

- The possibility of financial distress will become a chronic problem. - The benefits of debt financing may be more than offset by the costs of financial distress.

Financial distress can arise in the form of possible _____ - business failure - technical solvency - legal bankruptcy - accounting exactitude

- business failure - legal bankruptcy

______ is the term that describes the capital structure when debt is used to finance assets

financial leverage

the cost of debt is generally _________ than the cost of equity

lower/less

True or false: When total book liabilities exceed the book value of the total assets, a firm is said to have reached fallen angel insolvency.

false: it has reached accounting insolvency when book liabilities exceed the book value of total assets.

True or false: There is a precise mathematical equation for determining the optimal level of debt for any firm.

false: the optimal debt level is determined in a subjective manner.

The weighted average cost of capital rises at higher levels of debt owing to ___________

financial distress costs

Which of the following are generally true about the cost of equity and the cost of debt? - The cost of debt increases with leverage. - The cost of debt is generally lower than the cost of equity. - The cost of equity is generally lower than the cost of debt. - The cost of equity may increase with leverage.

- The cost of debt increases with leverage. - The cost of debt is generally lower than the cost of equity. - The cost of equity may increase with leverage.

True or false: Stockholders care most about the dividend maximization of the firm.

false: they care most about maximizing the overall value of the firm

What is generally the most important component of direct bankruptcy costs?

legal costs

The value of a levered firm will be greater than the value of an identical unlevered firm because the levered firm's taxes will be ______

lower

A beneficial rule to follow is to set the firm's capital structure so that the firm's value is _____

maximized