CF Chap 17

Which one of these lowers cash flows?

• A) Decreased use of leverage
• B) Decreased costs
• C) Increased sales due to an improved economy
• D) The associated costs of bankruptcy
• E) A decrease in the interest rate charged on deb

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

• A) debt flotation costs.
• B) beta conversion costs.
• C) direct costs of financial distress.
• D) indirect bankruptcy costs.
• E) unlevered costs of capital

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

• A) 3 percent
• B) 5 percent
• C) 8 percent
• D) 1 percent
• E) 10 percent

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

• A) Key employee leaving for another job due to concerns over job security given the company's financial status
• B) Loss of a key supplier due to late payments to that supplier
• C) Fees paid to financial advisors related to bankruptcy matters
• D) Loss of customers due to concerns the company will close
• E) Money spent to send a mailing to customers dispelling any and all financial distress concerns about the company

Conflicts of interest between stockholders and bondholders are known as:

• A) trustee costs.
• B) financial distress costs.
• C) dealer costs.
• D) agency costs.
• E) underwriting costs.

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

• A) the firm will rank all projects and select the project which results in the highest expected firm value.
• B) bondholders expropriate value from stockholders by selecting high-risk projects.
• C) stockholders expropriate value from bondholders by selecting high-risk projects.
• D) the firm will always select the lowest-risk project available.
• E) 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:

• A) the firm selecting all projects with positive NPVs.
• B) the firm turning down positive NPV projects that would clearly be accepted if the firm were all-equity financed.
• C) bondholders contributing the full amount of any new investment, but both stockholders and bondholders sharing in the benefits of those investments.
• D) shareholders making decisions based on the best interests of the bondholders.
• E) 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) A firm paying a premium to acquire a competitor
• B) A firm demanding a premium to be acquired without a proxy fight
• C) A firm with high financial distress paying additional dividends
• D) An all-equity firm repurchasing shares
• E) A firm with high financial distress using expected dividends to repay debt

Shareholders sometimes pursue selfish strategies when financial distress is present. These actions generally result in:

• A) no action by debtholders since these are shareholder concerns.
• B) agency costs to bondholders.
• C) investments with risks similar to those of the current firm.
• D) undertaking scale-enhancing projects.
• E) 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:

• A) restructuring their loans to provide additional time to the firm to make repayment.
• B) subordinating their bankruptcy position to the shareholders.
• C) agreeing to reduce the outstanding principal balances on their loans.
• D) agreeing to reduce the interest rate on existing loans.
• E) increasing the interest rate on monies loaned to the firm