Corporate Finance Quiz 7

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Aside from direct costs of bankruptcy, a firm may also incur other indirect costs such as: A. loss of customers and loss of suppliers B. loss of interest receipts C. loss of dividend receipts D. increase in raw material costs

A

Managerial entrenchment means that managers ________ and run the firm for their own best interests. A. may face little threat of being fired B. are overseen by equity holders C. are overseen by debt holders D. are well compensated

A

The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of: A. financial distress B. interest payments C. dividend reinvestment D. input factors

A

Firms in industries such as real estate tend to have ________ distress costs because of a large proportion of tangible assets. A. high B. low C. unexpected D. varying

B

The optimal capital structure depends on ________ such as taxes, distress costs and agency costs. A. capital market factors B. market imperfections C. firm specific risks D. systematic risks

B

The presence of a large amount of debt can encourage shareholders to take excessive risk because: A. equity holders are risk seeking by nature B. the costs of failure are borne largely by debt holders C. debt holders are risk seeking D. firm value increases with risk taking

B

To reduce agency costs, issuing debt instead of equity provides incentives for managers to run a firm efficiently because: A. debt increases the funds available to managers to run the firm B. ownership of managers may remain more concentrated C. managers may take actions that benefit shareholders but harm creditors and lower the value of the firm D. shareholders prefer to decline new projects to save cash, even if their NPVs are positive

B

A bankruptcy process is complex, time-consuming, and costly. The costs of bankruptcy include: A. dividend payments B. raw material costs C. costs of hiring legal experts, appraisers, and auctioneers D. taxes

C

One of the factors that determine the present value (PV) of financial distress costs is: A. costs of unpaid interest arrears B. loss of dividend payments C. probability of financial distress D. employee compensation

C

When a firm's investment decisions have different consequences for the value of equity and the value of debt, managers may take actions: A. to increase debt values B. to decrease costs of distress C. that benefit shareholders at the expense of debt holders D. to reduce fixed costs

C

Agency costs arise when: A. there are high labor costs B. input costs are higher than interest costs C. interest costs exceed dividend payments D. conflicts of interest exist between stakeholders

D

Scotts is currently in the Chapter 11 bankruptcy reorganization process, after which it will emerge as an unlevered firm by issuing new equity to claimants. At the time of filing, Scotts' debt consisted of a $6 billion senior bank loan and $4 billion of subordinated bonds. If the value of Hanjin's assets is estimated to be $8 billion, what are the respective shares of the reorganized equity owned by the bank and bondholders when Hanjin emerges from bankruptcy? A. Bank owns 50%, bondholders own 50% B. Bank owns 60%, bondholders own 40% C. Bank owns 75%, bondholders own 25% D. Bank owns 100%, bondholders own 0%

The bank receives $6 billion of value before bondholders receive anything. There is $2 billion leftover for bondholders. Thus, the bank owns $6 billion / $8 billion = 75% and bondholders own 25%.


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