Question 1

Use the information for the question(s)  below.
If it is managed efficiently, Luther Industries will have assets with a market value of $100 million, $300, million, or $500 million next year, with each outcome being equally likely. Managers may, however, engage in wasteful empire building which will reduce the firm's market value by $20 million in all cases. Managers may also increase the risk of the firm, changing the probability of each outcome to 50%, 20%, and 30% respectively.
-If its managers engage in empire building,then the expected market value of Luther's assets is closest to:

Accepted Answer

A)   $260 million
B)   $280 million
C)   $240 million
D)   $300 millionE) B) and C)
F) None of the above

Question 2

Which of the following industries is likely to have the lowest costs of financial distress?

Accepted Answer

A)   Airline
B)   Computer Software
C)   Biotechnology
D)   Electric UtilitiesE) B) and D)
F) None of the above D

Question 3

There are two relevant acts for financially distressed firms in Canada:

Accepted Answer

A)   the Bankruptcy and Insolvency Act (BI
A)   and the Companies' Registration Act (CR
A)  .
B)   the Bankruptcy and Insolvency Act (BI
A)   and the Companies' Creditors Arrangement Act (CCA
A)  .
C)   the Canada Business Corporations Act (CBC
A)   and the Companies' Creditors Arrangement Act (CCA
A)  .
D)   the Canada Business Corporations Act (CBC
A)   and the Canada's Corporations Act (CC
A)  E) None of the above
F) B) and D) B

Question 4

Which of the following statements is false?

Accepted Answer

A)   The most important insight regarding capital structure goes back to Modigliani and Miller: with perfect capital markets, a firm's security choice alters the risk of the firm's equity, but it does not change its value or the amount it can raise from outside investors.
B)   When agency costs are significant, short-term debt may be the most attractive form of external financing.
C)   Too much debt can motivate managers and equity holders to take excessive risks or over-invest in a firm.
D)   Of all the different possible imperfections that drive capital structure, the most clear-cut, and possibly the most significant, is taxes.E) C) and D)
F) All of the above

Question 5

Use the information for the question(s)  below.
Monsters Incorporated (MI)  is ready to launch a new product. Depending upon the success of this product, MI will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy (i.e. risk from the project is diversifiable)  so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume that the capital markets are perfect.
-Suppose that MI has zero-coupon debt with a $125 million face value due next year.The initial value of MI's debt is closest to:

Accepted Answer

A)   $125 million
B)   $111 million
C)   $100 million
D)   $116 millionE) None of the above
F) A) and B)

Question 6

Use the information for the question(s)  below.
Monsters Incorporated (MI)  is ready to launch a new product. Depending upon the success of this product, MI will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy (i.e. risk from the project is diversifiable)  so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume that the capital markets are perfect.
-Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year.The initial value of MI's equity is closest to:

Accepted Answer

A)   $30 million
B)   $29 million
C)   $15 million
D)   $24 millionE) A) and C)
F) B) and C)

Question 7

An under-investment problem suggests that shareholders choose to not invest in a ________ project.

Accepted Answer

A)   zero-NPV
B)   negative-NPV
C)   positive-NPV
D)   none of the aboveE) None of the above
F) B) and C)

Question 8

Canadian bankruptcy law was created to ensure that ________ are treated fairly and the value of the assets is not needlessly destroyed.

Accepted Answer

A)   shareholders
B)   stakeholders
C)   creditors
D)   ownersE) C) and D)
F) All of the above

Question 9

Use the information for the question(s)  below.
JR Industries has a $20 million loan due at the end of the year and under its current business strategy its assets will have a market value of only $15 million when the loan comes due. JR is considering a new, much riskier business strategy. While this new, riskier strategy can be implemented using JR's existing assets without any additional investment, the new strategy has only a 40% probability of succeeding. If the new strategy is a success, the market value of JR's assets will be $30 million, but if the strategy fails the assets will be worth only $5 million.
-What is the expected payoff to debt holders under JR's new riskier business strategy?

Accepted Answer

A)   $20 million
B)   $4 million
C)   $15 million
D)   $11 millionE) None of the above
F) A) and B)

Question 10

Which of the following industries likely to have the highest costs of financial distress?

Accepted Answer

A)   Grocery store
B)   Semiconductors
C)   Real estate
D)   UtilitiesE) B) and C)
F) All of the above

Question 11

Which of the following statements is false?

Accepted Answer

A)   Although indirect costs of bankruptcy are difficult to measure accurately, they are typically much smaller than the direct costs of bankruptcy.
B)   Bankruptcy protection can be used by management to delay the liquidation of a firm that should be shut down.
C)   Because many aspects of the bankruptcy process are independent of the size of the firm, the costs are typically higher, in percentage terms, for smaller firms.
D)   Aside from the direct legal and administrative costs of bankruptcy, many other indirect costs are associated with financial distress (whether or not the firm has formally filed for bankruptcy) .E) B) and C)
F) B) and D)

Question 12

The agency costs are the costs that arise when there are conflicts of interest

Accepted Answer

A)   between management and shareholders.
B)   between customers and suppliers.
C)   between stakeholders.
D)   between the board of directors and shareholders.E) A) and B)
F) A) and C)

Question 13

Use the information for the question(s)  below.
Monsters Incorporated (MI)  is ready to launch a new product. Depending upon the success of this product, MI will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy (i.e. risk from the project is diversifiable)  so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume that the capital markets are perfect.
-Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs and suppose that MI has zero-coupon debt with a $125 million face value due next year.The present value of MI's financial distress costs is closest to:

Accepted Answer

A)   $20.0 million
B)   $6.6 million
C)   $6.3 million
D)   $19.0 millionE) All of the above
F) A) and B)

Question 14

The BIA usually applies to ________ while the CCAA applies to firms that owe ________ to creditors.

Accepted Answer

A)   small businesses; $1 million or less
B)   big business; $1 million or less
C)   small businesses; $5 million or more
D)   big business; $5 million or moreE) A) and B)
F) A) and C) C

Question 15

If a Canadian publicly traded company deliberately misrepresents its earnings and it is also listed on a U.S.stock exchange,the U.S.Securities and Exchange Commission (SEC) may also pursue charges and fines,which are generally ________ those assessed in Canada.

Accepted Answer

A)   larger than
B)   smaller than
C)   equal to
D)   zero compared toE) A) and D)
F) A) and C)

Question 16

Which of the following statements is false?

Accepted Answer

A)   Creditors often place restrictions on the actions that the firm can take. Such restrictions are referred to as debt covenants.
B)   Covenants are often designed to prevent management from exploiting debt holders, so they may help to reduce agency costs.
C)   Agency costs are smallest for long-term debt.
D)   Covenants may limit the firm's ability to pay large dividends or the types of investments that the firm can make.E) A) and B)
F) A) and D)

Question 17

Use the information for the question(s)  below.
Monsters Incorporated (MI)  is ready to launch a new product. Depending upon the success of this product, MI will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy (i.e. risk from the project is diversifiable)  so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume that the capital markets are perfect.
-Suppose that MI has zero-coupon debt with a $125 million face value due next year.The yield to maturity of MI's debt is closest to:

Accepted Answer

A)   12.5%
B)   7.8%
C)   25.0%
D)   5.0%E) A) and B)
F) A) and C)

Question 18

Under the BIA,a firm may put forth a proposal that can either be accepted or rejected by its ________.

Accepted Answer

A)   creditors
B)   provincial government
C)   shareholders
D)   stakeholdersE) C) and D)
F) All of the above

Question 19

The idea that when a seller has private information about the value of good,buyers will discount the price they are willing to pay due to adverse selection is known as the

Accepted Answer

A)   pecking order hypothesis.
B)   signaling theory of debt.
C)   lemons principle.
D)   credibility principle.E) A) and B)
F) A) and C)

Question 20

Which of the following is NOT a direct cost of bankruptcy?

Accepted Answer

A)   Costs to Creditors
B)   Investment Banking Costs
C)   Costs of accounting experts
D)   Legal Costs and FeesE) All of the above
F) B) and C)

Exam 16: Financial Distress, managerial Incentives, and Information

Correct Answer
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Which of the following industries is likely to have the lowest costs of financial distress?

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D

There are two relevant acts for financially distressed firms in Canada:

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B

Which of the following statements is false?

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An under-investment problem suggests that shareholders choose to not invest in a ________ project.

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Canadian bankruptcy law was created to ensure that ________ are treated fairly and the value of the assets is not needlessly destroyed.

Correct Answer
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Which of the following industries likely to have the highest costs of financial distress?

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Which of the following statements is false?

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The agency costs are the costs that arise when there are conflicts of interest

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The BIA usually applies to while the CCAA applies to firms that owe to creditors.

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C

If a Canadian publicly traded company deliberately misrepresents its earnings and it is also listed on a U.S.stock exchange,the U.S.Securities and Exchange Commission (SEC) may also pursue charges and fines,which are generally ________ those assessed in Canada.

Correct Answer
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Which of the following statements is false?

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Under the BIA,a firm may put forth a proposal that can either be accepted or rejected by its ________.

Correct Answer
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The idea that when a seller has private information about the value of good,buyers will discount the price they are willing to pay due to adverse selection is known as the

Correct Answer
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Which of the following is NOT a direct cost of bankruptcy?

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Exam 16: Financial Distress, managerial Incentives, and Information

Correct AnswerverifiedShow Answer

Which of the following industries is likely to have the lowest costs of financial distress?

Correct AnswerverifiedD

There are two relevant acts for financially distressed firms in Canada:

Correct AnswerverifiedB

Which of the following statements is false?

Correct AnswerverifiedShow Answer

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Correct AnswerverifiedShow Answer

An under-investment problem suggests that shareholders choose to not invest in a ________ project.

Correct AnswerverifiedShow Answer

Canadian bankruptcy law was created to ensure that ________ are treated fairly and the value of the assets is not needlessly destroyed.

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Which of the following industries likely to have the highest costs of financial distress?

Correct AnswerverifiedShow Answer

Which of the following statements is false?

Correct AnswerverifiedShow Answer

The agency costs are the costs that arise when there are conflicts of interest

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

The BIA usually applies to ________ while the CCAA applies to firms that owe ________ to creditors.

Correct AnswerverifiedC

If a Canadian publicly traded company deliberately misrepresents its earnings and it is also listed on a U.S.stock exchange,the U.S.Securities and Exchange Commission (SEC) may also pursue charges and fines,which are generally ________ those assessed in Canada.

Correct AnswerverifiedShow Answer

Which of the following statements is false?

Correct AnswerverifiedShow Answer

Correct AnswerverifiedShow Answer

Under the BIA,a firm may put forth a proposal that can either be accepted or rejected by its ________.

Correct AnswerverifiedShow Answer

The idea that when a seller has private information about the value of good,buyers will discount the price they are willing to pay due to adverse selection is known as the

Correct AnswerverifiedShow Answer

Which of the following is NOT a direct cost of bankruptcy?

Correct AnswerverifiedShow Answer

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D

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B

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The BIA usually applies to while the CCAA applies to firms that owe to creditors.

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C

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