Question 1

The costs of avoiding a bankruptcy filing by a financially distressed firm are classified as _____ costs.

Accepted Answer

A)  indirect bankruptcy
B)  direct bankruptcy
C)  financial solvency
D)  capital structure
E)  flotation A

Question 2

The Sawmill plans on closing its doors after one more year.During its last year in business the firm expects to generate a cash flow of $74,000 if the economy booms and $57,000 if it does not.The probability of a boom is 15 percent.The firm has debt of $60,000 that is due in one year.That debt has a market value of $58,000 today.Ignore taxes.The current promised return on debt is ____ percent and the expected return on debt is ______ percent.

Accepted Answer

A)  3.78;-1.16
B)  3.45;-.95
C)  2.02;3.78
D)  3.45;2.67
E)  2.67;3.45 B

Question 3

Which one of these statements is correct for a levered firm?

Accepted Answer

A)  An increase in tax rates will decrease the value of the firm.
B)  An increase in financial distress costs increases the value of a firm.
C)  To obtain its maximum value,a firm should select an all-equity capital structure.
D)  The value of a firm is maximized when its cost of capital is also maximized.
E)  The optimal level of debt for a firm results in the value of that firm being maximized. E

Question 4

The explicit costs,such as the legal expenses,associated with corporate default are classified as _____ costs.

Accepted Answer

A)  unlevered
B)  beta conversion
C)  direct bankruptcy
D)  indirect bankruptcy
E)  flotation

Question 5

How might business risk affect the capital structure of a firm?

Accepted Answer

The answer of How might business risk affect the capital...

Question 6

Establishing a capital structure for a firm is not simple.Although financial theory guides the process,there is no quantifiable formula to follow.However,there are key factors which should be considered as they affect the target ratio.List and explain three such factors.

Accepted Answer

The answer of Establishing a capital structure for a firm...

Question 7

The free cash flow hypothesis supports:

Accepted Answer

A)  decreasing stockholder dividends to retain more cash within the firm.
B)  reducing a firm's level of debt to save the cash currently being spent on interest payments.
C)  increasing the debt portion of a firm's capital structure.
D)  hiring managers with little or no stock ownership in the firm.
E)  the idea that firms with high levels of free cash flow are more apt to make good acquisitions than firms with low levels.

Question 8

Which one of these best describes the relationship between bondholders and stockholders at a time when it appears the firm may be facing increased financial distress?

Accepted Answer

A)  Stockholders have an incentive to underinvest in new projects to the detriment of bondholders.
B)  Both parties tend to work together for the common good of the firm.
C)  Both bondholders and stockholders will encourage the firm to take on new high risk projects.
D)  Bondholders will tend to lower their required rate of interest so the firm can afford additional financing until its financial status improves.
E)  Bondholders tend to milk the property at the expense of stockholders.

Question 9

The legal proceeding for liquidating or reorganizing a firm operating in default is called a:

Accepted Answer

A)  tender offer.
B)  bankruptcy.
C)  merger.
D)  takeover.
E)  proxy fight.

Question 10

A firm is technically insolvent when:

Accepted Answer

A)  the value of its stock declines by more than 50 percent in any given 12-month period.
B)  the value of the firm's assets is less than the value of the firm's liabilities.
C)  it files the legal forms petitioning for bankruptcy protection.
D)  it is unable to meet its financial obligations.
E)  it has a negative net worth on its balance sheet.

Question 11

The Window Store will have a value of $163,000 if the economy does well this coming year and a value of $142,000 if the economy does poorly.The probability of a good economy is 55 percent.The firm owes its bondholders $54,000.The firm will only operate for one more year.What is the value of this firm to its shareholders?

Accepted Answer

A)  $98,500
B)  $99,550
C)  $100,450
D)  $153,550
E)  $154,450

Question 12

Explain a Section 363 bankruptcy and identify its primary benefit over a traditional bankruptcy.

Accepted Answer

The answer of Explain a Section 363 bankruptcy and identify...

Question 13

Which one of these statements most applies to a firm that is suffering from financial distress?

Accepted Answer

A)  Bondholders will desire high risk projects in order to protect their investment.
B)  Stockholders will increase their investment in the firm to protect their current investment.
C)  Stockholders will generally prefer low-risk over high-risk projects.
D)  Managers will tend to lower dividends in an effort to protect shareholder value.
E)  Stockholders will bear the cost of selfish investment strategies through higher interest payments.

Question 14

Burger Queen has a value of $26,000 in a good economy and $17,000 in a recession.The firm has $20,000 of debt.The probability of a recession is 50 percent.The firm is considering a project that would change the firm values to $27,000 in a good economy and $15,000 in a recession.Will shareholders be willing to accept this project? Why or why not?

Accepted Answer

A)  No;Because the project will lower firm value by $500
B)  No;Because the project will lower shareholder value by $500
C)  No;Because the firm will be worth less in a recession than it is currently
D)  Yes;Because the project will increase both firm and shareholder value by $500
E)  Yes;Because shareholder value will increase $500 at a cost of $1,000 to the bondholders

Question 15

The optimal capital structure has been achieved when the:

Accepted Answer

A)  weight of equity is equal to the weight of debt.
B)  debt-to-equity ratio selected results in the lowest possible weighted average cost of capital.
C)  firm is totally financed with debt.
D)  debt-to-equity ratio is such that the cost of debt exceeds the cost of equity.
E)  cost of equity is maximized.

Question 16

For next year,there is a 60 percent chance the economy will do well and Importers Unlimited will have a firm value of $321,000.If the economy tanks,the firm's value will decline to $241,000.The firm owes its bondholders $250,000.What is the value of this firm to its shareholders?

Accepted Answer

A)  $42,600
B)  $39,000
C)  $71,000
D)  $46,400
E)  $139,000

Question 17

Dairy Isle has a value of $41,000 in a good economy and $32,000 in a recession.The firm has $35,000 of debt.The probability of a recession is 50 percent.The firm is considering a project that would change the firm values to $43,000 in a good economy and $29,000 in a recession.Will shareholders be willing to accept this project? Why or why not?

Accepted Answer

A)  No;Because the project will lower firm value by $500
B)  No;Because the project will lower shareholder value by $500
C)  No;Because the firm will be worth less in a recession than it is currently
D)  Yes;Because the project will increase both firm and shareholder value by $1,000
E)  Yes;Because shareholder value will increase $1,000 at a cost of $1,500 to the bondholders

Question 18

Which one of the following statements concerning bankruptcy is correct?

Accepted Answer

A)  Bondholders have a greater incentive than stockholders to keep a firm from filing for bankruptcy.
B)  An indirect cost of bankruptcy is the loss of key employees.
C)  Bankruptcy is sometimes used as a means to increase payroll costs.
D)  The assets of a firm tend to increase in value when a firm is in financial distress.
E)  The administrative costs incurred in a bankruptcy are considered indirect bankruptcy costs.

Question 19

Issuing debt instead of new equity in a closely held firm more likely causes owner-managers to:

Accepted Answer

A)  work harder than they would if equity had been issued.
B)  consume more perquisites because the cost is passed on to the debtholders.
C)  enjoy more leisure time than they would with an equity issue.
D)  accept more unprofitable projects.
E)  shirk their duties as they have less capital at risk.

Question 20

Which one of the following statements is correct concerning a Chapter 7 bankruptcy?

Accepted Answer

A)  A firm reorganizes its operations in an effort to return to being a viable concern.
B)  A trustee will assume control of the firm's assets until those assets can be liquidated.
C)  Chapter 7 bankruptcies are always involuntary on the part of the firm.
D)  The claims of creditors are paid prior to the bankruptcy administrative costs.
E)  The firm generally issues new shares of stock prior to coming out of to bankruptcy.

Exam 15: Capital Structure: Limits to the Use of Debt