Corporate Finance (Final)
What are the steps of a Straight liquidation under Chapter 7?
1 A petition is filed in a federal court. The debtor firm (the Company) could file a voluntary petition, or the creditors/lenders/bondholders could file an involuntary petition against the firm. 2 A bankruptcy trustee is elected by the creditors to take over the assets of the debtor firm. The trustee will attempt to liquidate the firm's assets. 3 When the assets are liquidated, after payment of the costs of administration, money is distributed to the creditors. 4 If any assets are left over, the shareholders get it
What are the steps of a Bankruptcy Reorganization under Chapter 11?
1 A voluntary petition or an involuntary petition is filed. 2 A federal judge either approves or denies the petition. 3 In most cases the debtor (the Company) continues to run the business. 4 The firm is given 120 days to submit a reorganization plan. If it does, the corporation is given 180 days from the filing date to gain acceptance of the plan. 5 Creditors and shareholders are divided into classes. Requires only approval by 1/2 of the total number of creditors who own 2/3 of total outstanding debt. 6 After acceptance by the creditors, the plan is confirmed by the court. 7 Payments in cash, property, and securities are made to creditors and shareholders. The plan may provide for the issuance of new securities.
Given the following options, liquidation proceeds are distributed in what order of priority according to the absolute priority rule?
1 Administration expenses associated with liquidation - legal fees related to bankruptcy 2 Unsecured claims arising after the filing of an involuntary bankruptcy petition 3 Contributions to employee benefit plans within 180 days before the filing date 4 Consumer claims - accounts payables and other liabilities 5 Senior debt 6 Subordinated debt 7 Common equity
Based on our discussions in class, approximately what percentage of firms who go through financial distress end up Reorganizing and Emerging from Bankruptcy?
20%
Under the trade-off view of the optimal capital structure, what is the actual enterprise value of the firm given the following factors: Present value of financial distress costs = $(20)mm Present value of tax shield on debt = $40mm Enterprise value of the unlevered firm = $200mm
220mm
On the Income Statement, assume the total Depreciation of $300 is included in the General and Administrative Expenses and the total Amortization of $200 is included in Other Expenses, both subtracted from EBIT. EBIT = $600. Cash Taxes Paid = $(200). Based on our calculations of the Financial Cash Flows, what is the Operating Cash Flow?
900
When using IRR to evaluate independent project cash flows, which of the following is correct?
Accept a financing project if the IRR is less than the required return.
What does it mean if two projects are mutually exclusive?
Accepting one of the projects prevents you from accepting the other project
Which of the following is true about the trade off approach for the optimal capital structure?
Actual Value Created / (Destroyed) by Financial Leverage = Present value of tax shield on debt - Present value of financial distress costs
Which of the following choices is the most likely order in which a firm might go through restructuring activities in response to financial distress?
Adjust operating decisions to improve operating cash flow, attempt a private workout, file for Chapter 7 bankruptcy
Which valuation technique separately values the financing side effects outside of adjusting the discount rate?
Adjusted present value (APV) method
Which of the following is NOT an indirect bankruptcy cost?
Administrative costs and fees paid to lawyers and other experts to resolve problems
Which of the following is not a cost of financial distress?
Bankruptcy Risk
Suppose that Edge Corp. and Hunters Ridge Inc. have identical portfolios of rental properties with the same business risk and should have the same enterprise values. Suppose that Edge has a share price of $10 per share, 3 million shares outstanding, $5 million of debt, and $10,000,000 of cash. Suppose that Hunters Ridge has a share price of $5 per share, 6 million shares outstanding, $5 million of debt, and $5,000,000 of cash. Which of the following statements is correct?
Based on a comparison of enterprise values, we can say that Edge is undervalued relative to Hunters Ridge
You would like to compare your firm's capital structure to that of your competitors. However, your competitors are much larger in size than your firm. Which one of these would best enable you to compare costs across your industry?
Common-size balance sheet.
When calculating a firm's financial cash flows, and specifically the operating net working capital adjustment, match the isolated changes in operating current assets and liabilities with the appropriate cash adjustment?
CL decrease - cash decrease CA decrease - cash increases CL increase - Cash increases CA increase - Cash decreases
Which bankruptcy procedure is most likely to take longest amount of time to complete?
Chapter 11
Which of the following statements about the cost of debt is correct?
Cost of debt is generally lower than the cost of equity
Which of the following should be included as a cash flow in evaluating an investment project?
Costs associated with potential cash flows from alternative uses of assets used for this investment project.
Which of the following is not a direct factor in assessing the business risk of a firm?
Credit Spread
Which of the below terms would you NOT be able to find in the bond indenture?
Current Price
What is "Debtor in possession" (DIP) Financing?
Debt issued during a formal bankruptcy that is senior to all previously incurred debt
Which of the following TWO isolated changes would definitely increase the Sustainable Growth Rate?
Decrease Capital Intensity and Increase Debt-Equity Ratio
In the zero growth Dividend Discount Model, an increase in the required return (or cost of equity) is associated with which of the following (holding other factors constant)?
Decreases the implied equity value per share
Which of the following statements is an accurate description of using Discounted Cash Flow analysis to value a firm?
Discount forecasted free cash flows at the weighted-average cost of capital
What are the three most common valuation techniques?
Discounted Cash Flow Analysis, Comparable Company Analysis, Precedent Transaction Analysis
Based on the Dividend Discount Model, what are the two components of the required return (cost of equity) of a stock?
Dividend/Price + Growth Rate
Which of the following is an issue with the pecking-order theory?
Does not indicate a target Debt/Equity ratio
Which of the following statements about the Enterprise Value Multiples (as opposed to Price to Earnings (P/E) Multiples) is incorrect?
Enterprise Value Multiples allow you to estimate Enterprise Value when the firm of interest and its comparable companies have fundamentally different forecasted growth rates and sizes but other characteristics are the same
Which of the below describes a situation when the discount rate is appropriately estimated?
Executives would make the assumption that the business risk of the non-scale-enhancing project would be about equal to the business risk of firms already in the business
Match the key terms of financial distress with their definition
Financial Distress Firm is having difficulty generating the cash necessary to meet debt service requirements or fulfilling other terms of an indenture and the firm is forced to take corrective action Bankruptcy Legal proceeding and can be done voluntarily, with the corporation filing the petition, or involuntarily, with the creditors filing the petition Insolvency Value of the firm's assets is less than the value of the debt Default Borrower fails to make a payment at the scheduled time or abide by the terms of the loan
Which of the following statements
Financial and Accounting Cash Flows adjust profitability for depreciation and amortization
What are prepackaged bankruptcies?
Firm and most of its creditors agree to private reorganization plan outside the formal bankruptcy and then the firm files a formal bankruptcy under Chapter 11
Based on our discussions of the Circular Flow / Balance Sheet Model of a Firm, which statement best describes the Investing Decision?
Firm decides how to split financing cash flows between short-term and longterm assets. Cannot be a cash inflow
Which company generally has a higher likelihood of financial distress?
High financial leverage
Which of the following statements about holdout issues in resolving financial distress is correct?
Holdout issues are worse in private workouts, which require unanimity, vs. Chapter 11 bankruptcy
Assume that Capital Asset Pricing Model (CAPM) is the Security Market Line (SML) and therefore the correct project risk or required return for the project. Assume WACC is the WACC of the Company (co) as a whole, based on the Company's Beta(co). Match the Quadrant with the appropriate description.
I Always accept positive NPV projects because IRR > WACC and CAPM II If you use WACC instead of CAPM, you might accept negative NPV projects III If you use WACC instead of CAPM, you might reject positive NPV projects IV Always reject negative NPV projects because IRR < WACC and CAPM
Who benefits the least (i.e. does not benefit) from the tax shield?
IRS
Incremental IRR can be used for making investment decisions that address situations in which projects of different scale are mutually exclusive. Assume Project A is larger in scale than Project B, so investment and cash flows are higher. What does the incremental IRR tell us?
If incremental IRR is less than the discount rate, choose Project B. Means NPV(B)>NPV(A). If incremental IRR is higher than the discount rate, choose Project A. Means NPV(A)>NPV(B).
Which of the following statements about weighted average cost of capital (WACC) is NOT correct?
If possible, WACC should use book value weights for the costs of debt and equity
Suppose a firm must choose between two machines having unequal lives. Both machines can do the same job, but they have different operating costs and will last for different time periods. The firm anticipates that both machines can and will need to be replaced indefinitely. Assume Project B has a lifetime of 16 years and Project A has a lifetime of 8 years. When evaluating the two mutually exclusive projects, which of the following is NOT correct?
If the NPV of Project A is greater than the NPV of Project B, accept Project A
Which of the following does not accurately describe an agency cost of financial distress?
Impaired ability to conduct business (e.g., lost sales
Since inflation will likely occur during the expected life of a project, which of the following should you NOT do?
Include inflation in all cash flow forecasts and use a real discount rate
Which of the following is NOT a benefit of increasing financial leverage (increasing debt as a % of the capital structure)?
Increases cost of equity
If you are analyzing a public, manufacturing firm, and you calculate a Z-score of 3, what would this mean? Z= 3.3*EBIT/Totalassets+ 1.2*Networkingcapital/Totalassets+ 1.0*Sales/Totalassets+ 0.6*Marketvalueofequity/Bookvalueofdebt+ 1.4*Accumulatedretainedearnings/Totalassets Thresholds: 1 pts Edit this Question Delete this Question Z-Score < 1.81 Z-Score between 1.81 and 2.99 Z-Score > 2.99
Indicates low probability of bankruptcy
Assuming taxes, no bankruptcy/financial distress costs, and perpetual debt, the enterprise value of a levered firm exceeds the enterprise value of an unlevered firm by what amount?
Interest Paid/Interest Rate*Tax Rate
What would cause cost of debt to increase?
Interest Rate of comparable treasury or base yield increases
Which is typically lower: the Sustainable Growth Rate or Internal Growth Rate? Why?
Internal Growth Rate: does not allow for external financing
Based on our discussions of the Circular Flow / Balance Sheet Model of a Firm, what are the five key strategic financial decisions that a firm must make?
Investing, Operating, Payout, Liquidity, Financing
From the firm's perspective, which of the following statements in isolation certainly indicates a net cash outflow?
Issued $2,000 in short-term debt and retired $2,500 in long-term debt
Which of the following is a disadvantage of Bankruptcy vs. private workout?
Judges approve major business decisions
Which of the following is true about prepackaged bankruptcy?
Offers many of the advantages of a formal bankruptcy but is more efficient
What is definitely a good attribute for a company to have high financial leverage?
Low Capital expenditure requirements
All else equal, which of the following changes would NOT definitely increase or decrease the aftertax salvage value? In other words, which would you need additional information to know for sure if it would increase or decrease the after-tax salvage value?
Lower initial investment
What is the primary objective of the managers of the firm
Maximize the market value of equity of the Firm
Assuming reasonable assumptions are being used, which of the following accurately describes the most thorough approach to reviewing a project based on its Net Present Value (NPV)?
Monte Carlo Simulation
James River has 4 divisions, all of which have different βetas. If James River uses its overall firm βeta to calculate a firm cost of capital that will be used for all 4 divisions in making investment decisions, which of the following could happen? In this context, positive and negative describe the NPV based on a risk-adjusted discount rate based on the project's risk/βeta (not the firm's risk/βeta), and low/high risk is judged relative to James River's firm βeta with low risk having a project βeta < the firm's βeta and high risk having a project βeta > the firm's βeta.
Negative NPV, high risk projects could be incorrectly accepted
Which of the following is not an option in asset restructuring?
Negotiating with banks and other creditors, exchanging debt for equity, delay payment of debt and give debtholders the equity upside in the future
Based on our discussion of Intuit, when modeling the financial cash flows for the projected year (i.e. 2020), what is the best way to calculate the net change in Cash for the projected year, assuming we want Cash to be the "plug" variable to make the balance sheet balance?
Net Change in Cash = Free Cash Flow + Cash Flow from / (to) Creditors + Cash Flow from / (to) Shareholders
All else equal, what does decreasing the discount rate do to Payback Period?
No effect
Which of the following is NOT an appropriate response to mitigate potential costs of financial distress?
Pay higher dividends
Which of the following valuation techniques is most likely to have the highest valuation: Discounted Cash Flow Analysis, Precedent Transaction Analysis, or Comparable Companies Analysis?
Precedent Transaction Analysis
You are a financial analyst at a large corporation, and your CFO wants to determine how much COVID, the tax implications of the U.S. Presidential Election, and Climate Change can affect a project that you are evaluating. Which analysis is he most likely asking you to perform?
Scenario Analysis
Which of the following is NOT a correct description of Section 363 cases?
Section 363 cases are similar to traditional Chapter 7 cases in that the firm continues to operate with a new set of financial claims
What has the lowest required return in the capital structure?
Secured Debt
Generally, who suffers from bankruptcy?
Shareholders, Bondholders, and IRS
Which of the following is Not true?
Should use book value of debt when a company is in deep financial distress
Match the definitions of operating cash flow (assume no interest).
Top-down Sales − Cash costs − Cash Taxes Bottom-up Net Income + Depreciation Tax-shield (Sales − Cash costs) × (1 − Tax Rate) + Depreciation × Tax Rate
Based on our conversations, what is NOT Free Cash Flow?
Total cash available to all investors of the firm. Free Cash Flow must be used to pay creditors or pay shareholders.
Match the following optimal capital structure theories with the relevant descriptions
Trade-off Theory Optimize present value of tax shield on debt and present value of financial distress costs Signaling Theory Firms with high anticipated profits will take on a high level of debt, they have more pretax income to shield through interest and higher debt Agency Cost of Equity - Free Cash Flow Theory Increase in debt will reduce the ability of managers to pursue wasteful activities more effectively than dividend increases Pecking-Order Theory Firms prefer to issue debt rather than equity if internal financing is insufficient
What is the most inappropriate strategy in determining optimal capital structure?
Use free cash flow before debt and equity even if the benefits > costs of increasing financial leverage
Which of the following is false?
When evaluating a project, if the preliminary NPV calculation is greater than 0, then if the project is accepted, the project will definitely add value to the firm in reality
Assuming no transaction costs, no financial distress/bankruptcy costs, and individuals and corporations borrow at same rate, how does financial leverage affect Weighted Average Cost of Capital (WACC) without taxes? With taxes?
Without taxes, WACC is unaffected by capital structure; With taxes, WACC increases as financial leverage decreases
What is NOT true about the deductibility limit for the tax shield based on the current tax code?
You cannot carry forward the tax benefit for future years