Chapter 17 CF

Which one of these lowers cash flows?

• Decreased use of leverage

• Decreased costs

• Increased sales due to an improved economy

• The associated costs of bankruptcy

• E) A decrease in the interest rate charged on debt

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

• debt flotation costs

• beta conversion costs

• direct costs of financial distress

• indirect bankruptcy costs

• unlevered costs of capital.

What is the estimated direct cost of financial distress as a percentage of the market value of afirm as estimated by White, Altman, and Weiss?

• 3 percent

• 5 percent

• 8 percent

• 1 percent

• 10 percent

Which one of the following is a direct, rather than an indirect, cost of financial distress?

• Key employee leaving for another job due to concerns over job security given the company'sfinancial status

• Loss of a key supplier due to late payments to that supplier

• Fees paid to financial advisors related to bankruptcy matters

• Loss of customers due to concerns the company will close

• Money spent to send a mailing to customers dispelling any and all financial distress concernsabout the company

Conflicts of interest between stockholders and bondholders are known as

• trustee costs

• financial distress costs

• dealer costs

• agency costs

• underwriting costs

One of the indirect costs of bankruptcy is the effect that a potential bankruptcy has on thefirm's decisions. The general result is that

• the firm will rank all projects and select the project which results in the highest expected firmvalue.

• bondholders expropriate value from stockholders by selecting high-risk projects

• stockholders expropriate value from bondholders by selecting high-risk projects

• the firm will always select the lowest-risk project available

• the firm will select only all-equity financed projects.

One of the indirect costs of bankruptcy is the incentive toward underinvestment. Underinvestment generally would result in

• the firm selecting all projects with positive NPVs

• the firm turning down positive NPV projects that would clearly be accepted if the firm were all-equity financed.

• bondholders contributing the full amount of any new investment, but both stockholders andbondholders sharing in the benefits of those investments.

• shareholders making decisions based on the best interests of the bondholders

• the firm accepting more projects than it would if the probability of bankruptcy was ignored.

Which one of these best exemplifies "milking the property"?

• A firm paying a premium to acquire a competitor

• A firm demanding a premium to be acquired without a proxy fight

• A firm with high financial distress paying additional dividends

• An all-equity firm repurchasing shares

• A firm with high financial distress using expected dividends to repay debt

Shareholders sometimes pursue selfish strategies when financial distress is present. Theseactions generally result in

• no action by debtholders since these are shareholder concerns

• agency costs to bondholders

• investments with risks similar to those of the current firm

• undertaking scale-enhancing projects

• lower agency costs, as shareholders have more control over the firm's assets

Bondholders tend to offset the effects of selfish strategies implemented by shareholders by:

• restructuring their loans to provide additional time to the firm to make repayment

• subordinating their bankruptcy position to the shareholders.

• agreeing to reduce the outstanding principal balances on their loans.

• agreeing to reduce the interest rate on existing loans.

• increasing the interest rate on monies loaned to the firm.