Chapter 13 Study Guide

Which one of the following statements is correct?

A firm can file for Chapter 11 bankruptcy even if the firm is solvent

Assume both corporate taxes and financial distress costs apply to a firm. Given this, the static theory of capital structure illustrates that:

A firm's value and its WACC are inversely related

Which one of the following statements related to the static theory of capital structure is correct?

A firm's value is maximized when a firm operates at its optimal debt level

Which one of the following best defines legal bankruptcy?

A legal proceeding for liquidating or reorganizing a business

In the process of liquidation, some types of claims receive preference over other claims. Which one of the following determines which type of claim is paid first?

Absolute priority rule

Which one o the following will generally receive the highest priority in a bankruptcy liquidation, assuming the absolute priority rule is followed?

Bankruptcy administrative expenses

Which one of the following statements is correct?

Bankruptcy courts have cram down powers

Which one of the following is the equity risk arising from the daily operations of a firm?

Business risk

The level of financial risk to which a firm is exposed is dependent on the firms:

Debt equity ratio

Which one of the following terms is inclusive of both direct and indirect bankruptcy costs?

Financial distress costs

Which one of the following statements concerning financial leverage is correct?

Financial leverage magnifies both profits and losses

Which one of the following is the equity risk arising from the capital structure selected by a firm?

Financial risk

The use of borrowing by an individual to adjust his or her overall exposure to financial leverage is referred to as:

Homemade leverage

Which one of the following will increase the value of a levered firm according to M&M Proposition !, with taxes?

Increase in the value of the unleveled firm

Which one of the following is an example of a direct bankruptcy cost?

Incurring legal fees for the preparation of bankruptcy filings

Which one of the following terms applies to the costs incurred by a firm that is trying to avoid filing for bankruptcy?

Indirect bankruptcy costs

Paying interest reduces the taxes owed by a firm. Which one of the following terms applies to this relationship?

Interest tax shield

The static theory of capital structure assumes a firm:

Is fixed in terms of its assets

A prepack:

Is the joint filing of both a bankruptcy filing and a creditor approved reorganization plan

Which one of the following is a direct bankruptcy cost?

Legal and accounting fees related to a bankruptcy proceeding

Which one of the following terms refers to the termination of a firm as a going concern?

Liquidation

Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?

M&M Proposition I, with taxes

Which one of the following states that a firm's cost of equity capital is a positive linear function of the firm's capital structure?

M&M Proposition II

Peterboro recently defaulted on a bank loan. To avoid a bankruptcy proceeding, the bank agreed to a composition. This composition would do which one of the following?

Reduce the amount of the loan payments to Peterboro can pay on time

Greenwood Motels has filed a petition for bankruptcy but hopes to continue its operations both during and after the bankruptcy process. Which one of the following terms best applies to this situation?

Reorganization

Which one of the following is a kew provision of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005?

Right granted to creditors toile their own reorganization plan once a firm is in bankruptcy for 18 months

TLC enterprises just revised its capital structure from a debt equity ratio of .30 to a debt equity ratio of .45. The firm's shareholders who prefer the old capital structure should:

Sell some shares and loan out the sale proceeds

Which one of the following is the theory that a firm should borrow up to the point where the additional tax benefit from an extra dollar of debt equals the additional costs associated with financial distress from that additional debt?

Static theory of capital structure

Which one of the following represents the present value of the interest tax shield?

Tc X D

Which of the following statements is the core principle of M&M Proposition I, without taxes?

The capital structure of a firm is totally irrelevant

Which one of the following is correct based on the static theory of capital structure?

The cost of financial distress decrease the value of a firm

Which one of the following statements correctly relate to M&M Proposition I, with taxes?

The levered value of a firm exceeds the firm's unleveled value

Which one of the following is an implication of M&M Proposition II, without taxes?

The risk of equity depends on both the degree of financial leverage and the riskiness of the firm's operations

Assume you are comparing two firms that are identical in every aspect, except one is levered and one is unlettered. Which one of the following statements is correct regarding these two firms?

The unleveled firm will have higher EPS at a relatively low levels of EBIT

Which one of the following statements matches M&M Proposition I?

The value of a firm is independent of the firm's capital structure

Which one of the following is minimized when the value of the firm is maximized?

WACC

Which one of the following conditions exists at the point where a firm maximizes its value?

WACC is minimized

When is a firm insolvent from an accounting perspective?

When it has negative net worth

You are comparing two possible capital structures for a firm. The first option is an all-equity firm. The second option involves the use of $3.8 million of debt. The break even point between these two financing options occurs with the EBIT are 428,000. Given this, you know that leverage is beneficial to the firm:

Whenever EBIT exceeds 428,000

M&M Proposition II without taxes states that the:

cost of squirt increases as a firm increases its debt equity ratio

Which one of the following statements concerning financial leverage is correct?

Changes in the capital structure of a firm will generally change the firm's earnings per share