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Financial Management 2017 - Quiz and Case Study Guides - Corporate Finance, 4e (Berk / DeMarzo) - Quiz - Chapter 16

Financial Management 2016 - 2017

FINANCIAL MANAGEMENT 2017 - QUIZ AND CASE STUDY GUIDES

Corporate Finance, 4e (Berk / DeMarzo)

Chapter 16   Financial Distress, Managerial Incentives, and Information

 

Corporate Finance, 4e (Berk / DeMarzo)

Chapter 16   Financial Distress, Managerial Incentives, and Information

 

16.1   Default and Bankruptcy in a Perfect Market

 

1) Which of the following statements is FALSE?

  1. A) Equity holders expect to receive dividends and the firm is legally obligated to pay them.
  2. B) A firm that fails to make the required interest or principal payments on the debt is in default.
  3. C) In the extreme case, the debt holders take legal ownership of the firm's assets through a process called bankruptcy.
  4. D) After a firm defaults, debt holders are given certain rights to the assets of the firm.

Answer:  A

Diff: 1

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Conceptual

 

2) Which of the following statements is FALSE?

  1. A) An important consequence of leverage is the risk of bankruptcy.
  2. B) Whether default occurs depends on the cash flows, not on the relative values of the firm's assets and liabilities.
  3. C) Economic distress is a significant decline in the value of a firm's assets, whether or not it experiences financial distress due to leverage.
  4. D) Modigliani and Miller's results continue to hold in a perfect market even when debt is risky and the firm may default.

Answer:  B

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Conceptual

 

Use the information for the question(s) below.

 

Monsters Incorporated (MI) in 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.

 

3) The initial value of MI's equity without leverage is closest to:

  1. A) $133 million
  2. B) $147 million
  3. C) $140 million
  4. D) $150 million

Answer:  C

Explanation:  C) VU =  = $140 million

Diff: 1

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

4) 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:

  1. A) $125 million
  2. B) $111 million
  3. C) $100 million
  4. D) $116 million

Answer:  B

Explanation:  B) Vdebt =  = $111.11 million

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

 

5) 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:

  1. A) 12.5%
  2. B) 7.8%
  3. C) 25.0%
  4. D) 5.0%

Answer:  A

Explanation:  A) Vdebt =  = $111.11 million

 

YTM =  - 1 = .125011 or 12.5%

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

6) Suppose that MI has zero-coupon debt with a $125 million face value due next year.  The expected return of MI's debt is closest to:

  1. A) 25.0%
  2. B) 12.5%
  3. C) 5.0%
  4. D) 7.8%

Answer:  C

Explanation:  C) Vdebt =  = $111.11 million

 

Expected Return =  = .05 or 5%

Diff: 3

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

7) 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:

  1. A) $30 million
  2. B) $15 million
  3. C) $29 million
  4. D) $24 million

Answer:  C

Explanation:  C) VL =  = $28.89 million

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

8) Suppose that MI has zero-coupon debt with a $125 million face value due next year.  The total value of MI with leverage is closest to:

  1. A) $133 million
  2. B) $140 million
  3. C) $147 million
  4. D) $125 million

Answer:  B

Explanation:  B) VL =  = $28.89 million

 

Vdebt =  = $111.11 million

 

Total Value = VL + Vdebt = $28.89 + $111.11 = $140 million

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

Use the information for the question(s) below.

 

Kinston Enterprises has no debt and a debt obligation of $47 million that is due now.  The market value of Kinston's assets is $102 million, and the firm has no other liabilities.  Assume that capital markets are perfect and that Kinston has 5 million shares outstanding.

 

9) Kinston's current share price is closest to:

  1. A) $20.40
  2. B) $9.40
  3. C) $11.00
  4. D) $10.00

Answer:  C

Explanation:  C) Price =  = $11.00 per share

Diff: 1

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

10) The number of new shares that Kinston must issue to raise the capital needed to pay its debt obligation is closest to:

  1. A) 4.3 million
  2. B) 4.7 million
  3. C) 5.0 million
  4. D) 4.0 million

Answer:  A

Explanation:  A) Price =  = $11.00 per share

 

Number of Shares =  = 4,272,728 shares

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

Use the information for the question(s) below.

 

Monsters Incorporated (MI) in 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.

 

11) Suppose that MI has zero-coupon debt with a $140 million face value due next year.  Calculate the value of levered equity, the value of debt, and the total value of MI with leverage.

Answer:  VL =  = $19.37 million

 

Vdebt =  = $120.63 million

 

Total Value = VL + Vdebt = $19.37 + $120.63 = $140 million

Diff: 2

Section:  16.1 Default and Bankruptcy in a Perfect Market

Skill:  Analytical

 

16.2   The Costs of Bankruptcy and Financial Distress

 

1) Taggart Transcontinental has a value of $500 million if it continues to operate, but has outstanding debt of $600 million. If Taggart declares bankruptcy, bankruptcy costs will equal $50 million, and the remaining $450 million will go to creditors. Instead of declaring bankruptcy, Taggart proposes to exchange the firm's debt for a fraction of its equity in a workout. The minimum fraction of the firm's equity that Taggart would need to offer to its creditors for the workout to be successful is closest to:

  1. A) 50%
  2. B) 75%
  3. C) 83%
  4. D) 90%

Answer:  D

Explanation:  D) Debt holders will need to be at least as well off as if the firm went into liquidation. In liquidation the debt holders would receive $450 million, however if the firm continues to operate it will have a value of $500 million. Therefore, $450 million = percent ownership for debt holders × $500 total value.

Solving for percent ownership gives $450/$500 = 90%

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Analytical

 

Use the following information to answer the question(s) below.

 

Suppose that you have received two job offers. Rearden Metal offers you a contract for $75,000 per year for the next two years while Wyatt Oil offers you a contract for $90,000 per year for the next two years. Both jobs are equivalent. Suppose that Rearden Metal's contract is certain, but Wyatt Oil has a 60% chance of going bankrupt at the end of the year. In the event that Wyatt Oil files for bankruptcy, it will cancel your contract and pay you the lowest amount possible for you to not quit. If you do quit, you expect you could find an new job paying $75,000 per year, but you would be unemployed for four months while searching for this new job.

 

2) If you take the job with Wyatt Oil, then, in the event of bankruptcy, the least amount that Wyatt Oil would pay you next year is closest to:

  1. A) $45,000
  2. B) $50,000
  3. C) $54,000
  4. D) $75,000

Answer:  B

Explanation:  B) If you quit, you will be out of work for 4 months searching for a job leaving 8 months of employment at $75,000 per year or  × $75,000 = $50,000

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Analytical

 

3) Assuming your cost of capital is 6 percent, the present value of your expected wage if you accept Rearden Metal's offer is closest to:

  1. A) $133,000
  2. B) $138,000
  3. C) $140,000
  4. D) $144,000

Answer:  B

Explanation:  B) PVRearden =  +  = $137,504.45

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Analytical

 

4) Assuming your cost of capital is 6 percent, the present value of your expected wage if you accept Wyatt Oil's offer is closest to:

  1. A) $138,000
  2. B) $140,000
  3. C) $144,000
  4. D) $150,000

Answer:  C

Explanation:  C) If you quit, you will be out of work for 4 months searching for a job leaving 8 months of employment at $75,000 per year or  × $75,000 = $50,000

PVWyatt =  +  = $143,645.43

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Analytical

5) Assuming your cost of capital is 6 percent, based on the present value of your expected wage you should:

  1. A) accept Rearden's offer since the PV of your expected wage would be approximately $6000 higher.
  2. B) accept Rearden's offer since the PV of your expected wage would be approximately $8000 lower.
  3. C) accept Rearden's offer since the PV of your expected wage would be approximately $8000 higher.
  4. D) accept Wyatt's offer since the PV of your expected wage would be approximately $6000 higher.

Answer:  D

Explanation:  D) If you quit, you will be out of work for 4 months searching for a job leaving 8 months of employment at $75,000 per year or  × $75,000 = $50,000

PVWyatt =  +  = $143,645.43

PVRearden =  +  = $137,504.45

Difference = 143,645.43 - 137,504.45 = $6140.98 ← Amount better off by accepting Wyatt's offer.

Diff: 3

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Analytical

 

6) Which of the following statements is FALSE?

  1. A) When a firm fails to make a required payment to debt holders, it is in bankruptcy.
  2. B) With perfect capital markets, the risk of bankruptcy is not a disadvantage of debt—bankruptcy simply shifts the ownership of the firm from equity holders to debt holders without changing the total value available to all investors.
  3. C) Bankruptcy is a long and complicated process that imposes both direct and indirect costs on the firm and its investors that the assumption of perfect capital markets ignores.
  4. D) Bankruptcy is rarely simple and straightforward—equity holders don't just "hand the keys" to debt holders the moment the firm defaults on a debt payment.

Answer:  A

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

7) Which of the following statements is FALSE?

  1. A) The U.S. bankruptcy code was created to organize this process so that creditors are treated fairly and the value of the assets is not needlessly destroyed.
  2. B) Because the assets of the firm might be more valuable if kept together, creditors seizing assets in a piecemeal fashion might destroy much of the remaining value of the firm.
  3. C) Debt holders can then take legal action against the firm to collect payment by seizing the firm's assets.
  4. D) Because most firms have multiple creditors, coordination makes it difficult to guarantee that each creditor will be treated fairly.

Answer:  D

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

8) Which of the following statements is FALSE?

  1. A) According to the provisions of the 1978 Bankruptcy Reform Act, U.S. firms can file for two forms of bankruptcy protection: Chapter 11 or Chapter 13.
  2. B) The Chapter 11 reorganization plan specifies the treatment of each creditor of the firm. In addition to cash payment, creditors may receive new debt or equity securities of the firm. The value of cash and securities is generally less than the amount each creditor is owed, but more than the creditors would receive if the firm were shut down immediately and liquidated.
  3. C) In the more common form of bankruptcy for large corporations, Chapter 11 reorganization, all pending collection attempts are automatically suspended, and the firm's existing management is given the opportunity to propose a reorganization plan.
  4. D) While developing a Chapter 11 reorganization plan, management continues to operate the business.

Answer:  A

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

 

9) Which of the following statements is FALSE?

  1. A) The creditors must vote to accept the Chapter 11 reorganization plan, and the bankruptcy court must approve it. If an acceptable plan is not put forth, the court may ultimately force a Chapter 7 liquidation of the firm.
  2. B) In Chapter 13 liquidation, a trustee is appointed to oversee the liquidation of the firm's assets through an auction. The proceeds from the liquidation are used to pay the firm's creditors, and the firm ceases to exist.
  3. C) When a corporation becomes financially distressed, outside professionals, such as legal and accounting experts, consultants, appraisers, auctioneers, and others with experience selling distressed assets, are generally hired.
  4. D) In the case of Chapter 11 reorganization, creditors must often wait several years for a reorganization plan to be approved and to receive payment.

Answer:  B

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

10) Which of the following statements is FALSE?

  1. A) Whether paid by the firm or its creditors, the indirect costs of bankruptcy increase the value of the assets that the firm's investors will ultimately receive.
  2. B) In addition to the money spent by the firm, the creditors may incur costs during the bankruptcy process.
  3. C) The bankruptcy code is designed to provide an orderly process for settling a firm's debts.
  4. D) To ensure that their rights and interests are respected, and to assist in valuing their claims in a proposed reorganization, creditors may seek separate legal representation and professional advice.

Answer:  A

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

11) Which of the following statements is FALSE?

  1. A) The direct costs of bankruptcy are likely to be higher for firms with more complicated business operations and for firms with larger numbers of creditors, because it may be more difficult to reach agreement among many creditors regarding the final disposition of the firm's assets.
  2. B) In a prepackaged bankruptcy (or "prepack") a firm will first develop a reorganization plan with the agreement of its main creditors, and then file Chapter 7 to implement the plan and pressure any creditors who attempt to hold out for better terms.
  3. C) A study of Chapter 7 liquidations of small businesses found that the average direct costs of bankruptcy were 12% of the value of the firm's assets.
  4. D) Studies typically report that the average direct costs of bankruptcy are approximately 3% to 4% of the pre-bankruptcy market value of total assets.

Answer:  B

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

 

12) Which of the following statements is FALSE?

  1. A) Although indirect costs of bankruptcy are difficult to measure accurately, they are typically much smaller than the direct costs of bankruptcy.
  2. B) Bankruptcy protection can be used by management to delay the liquidation of a firm that should be shut down.
  3. 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.
  4. 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).

Answer:  A

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

13) Which of the following statements is FALSE?

  1. A) The costs of selling assets below their value are greatest for firms with assets that lack competitive, liquid markets.
  2. B) Firms in financial distress tend to have difficulty collecting money that is owed to them.
  3. C) Suppliers may be unwilling to provide a firm with inventory if they fear they will not be paid.
  4. D) The loss of customers is likely to be large for producers of raw materials (such as sugar or aluminum), as the value of these goods, once delivered, depends on the seller's continued success.

Answer:  D

Diff: 2

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

14) Which of the following is NOT an indirect cost of bankruptcy?

  1. A) Legal fees
  2. B) Delayed liquidation
  3. C) Costs to creditors
  4. D) Loss of customers

Answer:  A

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

15) Which of the following is NOT an indirect cost of bankruptcy?

  1. A) Loss of suppliers
  2. B) Fire sales of assets
  3. C) Costs of appraisers
  4. D) Loss of employees

Answer:  C

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

 

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

  1. A) Costs to creditors
  2. B) Investment banking costs
  3. C) Costs of accounting experts
  4. D) Legal costs and fees

Answer:  A

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

17) Because debtor-in-possession (DIP) financing is senior to all existing creditors:

  1. A) it allows a firm that has filed for bankruptcy renewed access to financing to keep operating.
  2. B) it is an important cost for firms that rely heavily on trade credit.
  3. C) it is likely to be small for producers of raw materials, as the value of those goods, once delivered, does not depend on the seller's continued success.
  4. D) it allows debtors to assume they may have an opportunity to avoid their obligations to a firm.

Answer:  A

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Definition

 

18) List five general categories of indirect costs associated with bankruptcy.

Answer:  Indirect Costs:

Costs to Creditors

Loss of Customers

Loss of Suppliers

Loss of Employees

Loss of Receivables

Fire Sales of Assets

Delayed Liquidation

Diff: 1

Section:  16.2 The Costs of Bankruptcy and Financial Distress

Skill:  Conceptual

 

 

16.3   Financial Distress Costs and Firm Value

 

1) Which of the following statements is FALSE?

  1. A) Debt holders are not foolish—they recognize that when the firm defaults, they will not be able to get the full value of the assets. As a result, they will pay less for the debt initially.
  2. B) The costs of financial distress represent an important departure from Modigliani and Miller's assumption of perfect capital markets.
  3. C) Levered firms risk incurring financial distress costs that reduce the cash flows available to investors.
  4. D) When securities are fairly priced, the original shareholders of a firm pay the future value of the costs associated with bankruptcy and financial distress.

Answer:  D

Diff: 1

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Conceptual

Use the information for the question(s) below.

 

Monsters Incorporated (MI) in 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.

 

2) Assuming that in the event of default, 20% of the value of MI's assets will be lost in bankruptcy costs, the initial value of MI's equity without leverage is closest to:

  1. A) $150 million
  2. B) $147 million
  3. C) $140 million
  4. D) $133 million

Answer:  C

Explanation:  C) VU =  = $140 million

Diff: 1

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

 

3) 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 debt is closest to:

  1. A) $110 million
  2. B) $105 million
  3. C) $125 million
  4. D) $111 million

Answer:  B

Explanation:  B) Vdebt =  = $104.76 million

Diff: 2

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

 

4) 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 yield to maturity of MI's debt is closest to:

  1. A) 13.75%
  2. B) 5.00%
  3. C) 19.25%
  4. D) 12.50%

Answer:  C

Explanation:  C) Vdebt =  = $104.76 million

YTM =  - 1 = .193182 or 19.3%

Diff: 2

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

5) 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:

  1. A) $30 million
  2. B) $29 million
  3. C) $15 million
  4. D) $24 million

Answer:  B

Explanation:  B) VL =  = $28.89 million

Diff: 2

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

 

 

6) 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 total value of MI with leverage is closest to:

  1. A) $140 million
  2. B) $100 million
  3. C) $125 million
  4. D) $134 million

Answer:  D

Explanation:  D) VL =  = $28.89 million

 

Vdebt =  = $104.76 million

 

Total Value = VL + Vdebt = $28.89 + $104.76 = $133.65 million

Diff: 2

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

 

7) 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:

  1. A) $20.0 million
  2. B) $6.6 million
  3. C) $6.3 million
  4. D) $19.0 million

Answer:  C

Explanation:  C) PV(Financial Distress Costs) =  = $6.349 million

Diff: 2

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

8) Assume that in the event of default, 20% of the value of MI's assets will be lost in bankruptcy costs.  Suppose that at the start of the year, MI has no debt outstanding, but has 5.6 million shares of stock outstanding.  If MI does not issue debt, its share price is closest to:

  1. A) $5.15
  2. B) $23.75
  3. C) $23.90
  4. D) $25.00

Answer:  D

Explanation:  D) VU =  = $140 million

 

Price per Share = $140M/5.6 million shares = $25.00

Diff: 1

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

 

9) Assume that in the event of default, 20% of the value of MI's assets will be lost in bankruptcy costs.  Suppose that at the start of the year, MI has no debt outstanding, but has 5.6 million shares of stock outstanding.  If MI issues debt of $125 million due next year and uses the proceeds to repurchase shares, the share price following the announcement of the repurchase will be closest to:

  1. A) $23.90
  2. B) $23.75
  3. C) $25.00
  4. D) $5.15

Answer:  A

Explanation:  A) VL =  = $28.89 million

 

Vdebt =  = $104.76 million

 

Total Value = VL + Vdebt = $28.89 + $104.76 = $133.65 million

 

Price per Share = $133.65M/5.6 million shares = $23.87

Diff: 3

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

10) 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 $140 million face value due next year.  Calculate the value of levered equity, the value of debt, and the total value of MI with leverage.

Answer:  VL =  = $19.37 million

 

Vdebt =  = $114.29 million

 

Total Value = VL + Vdebt = $19.37 + $114.29 = $133.66 million

Diff: 3

Section:  16.3 Financial Distress Costs and Firm Value

Skill:  Analytical

 

 

16.4   Optimal Capital Structure: The Trade-off Theory

 

Use the following information to answer the question(s) below.

 

d'Anconia Copper is considering issuing one year debt, and has come up with the following estimates of the value of the interest tax shield and the probability of distress for different levels of debt:                                                        

 

 

1) If in the event of distress, the present value of distress costs is equal to $10 million, then the optimal level of debt for d'Anconia Copper is:

  1. A) $25 million
  2. B) $50 million
  3. C) $60 million
  4. D) $70 million

Answer:  C

Explanation:  C) Select $60 million since it has the highest net benefit.

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

2) If in the event of distress, the present value of distress costs is equal to $5 million, then the optimal level of debt for d'Anconia Copper is:

  1. A) $25 million
  2. B) $50 million
  3. C) $60 million
  4. D) $70 million

Answer:  D

Explanation:  D) Select $70 million since it has the highest net benefit.

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

3) If in the event of distress, the present value of distress costs is equal to $25 million, then the optimal level of debt for d'Anconia Copper is:

  1. A) $50 million
  2. B) $60 million
  3. C) $70 million
  4. D) $80 million

Answer:  A

Explanation:  A) Select $50 million since it has the highest net benefit.

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

4) Which of the following statements is FALSE?

  1. A) The tradeoff theory weighs the costs of debt that result from shielding cash flows from taxes against the benefits from the effects of financial distress associated with leverage.
  2. B) Leverage has costs as well as benefits.
  3. C) According to the tradeoff theory, the total value of a levered firm equals the value of the firm without leverage plus the present value of the tax savings from debt, less the present value of financial distress costs.
  4. D) Firms have an incentive to increase leverage to exploit the tax benefits of debt. But with too much debt, they are more likely to risk default and incur financial distress costs.

Answer:  A

Diff: 1

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual

 

5) Which of the following statements is FALSE?

  1. A) Calculating the precise present value of financial distress costs is a relatively straightforward process.
  2. B) Two key qualitative factors determine the present value of financial distress costs: (1) the probability of financial distress and (2) the magnitude of the costs after a firm is in distress.
  3. C) Technology firms are likely to incur high costs when they are in financial distress, due to the potential for loss of customers and key personnel, as well as a lack of tangible assets that can be easily liquidated.
  4. D) The magnitude of the financial distress costs will depend on the relative importance of the sources of these costs and is likely to vary by industry.

Answer:  A

Diff: 1

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual

 

6) Which of the following statements is FALSE?

  1. A) Real estate firms are likely to have low costs of financial distress, as much of their value derives from assets that can be sold relatively easily.
  2. B) For low levels of debt, the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield, which has present value τ*D, where τ* is the effective tax advantage of debt.
  3. C) Firms whose value and cash flows are very volatile (for example, semiconductor firms) must have much higher levels of debt to avoid a significant risk of default.
  4. D) The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.

Answer:  C

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual

 

7) Which of the following statements is FALSE?

  1. A) Firms with steady, reliable cash flows, such as utility companies, are able to use high levels of debt and still have a very low probability of default.
  2. B) If there were no costs of financial distress, the value of the firm would continue to increase with increasing debt until the interest on the debt exceeds the firm's earnings before interest and taxes and the tax shield is exhausted.
  3. C) The costs of financial distress reduce the value of the levered firm, VL. The amount of the reduction decreases with the probability of default, which in turn increases with the level of the debt D.
  4. D) The tradeoff theory states that firms should increase their leverage until it reaches the level D* for which VLis maximized.

Answer:  C

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual

 

8) Which of the following statements is FALSE?

  1. A) The presence of financial distress costs can explain why firms choose debt levels that are too high to fully exploit the interest tax shield.
  2. B) With higher costs of financial distress, it is optimal for the firm to choose lower leverage.
  3. C) Differences in the magnitude of financial distress costs and the volatility of cash flows can explain the differences in the use of leverage across industries.
  4. D) At the point D*, where VLis maximized, the tax savings that result from increasing leverage are just offset by the increased probability of incurring the costs of financial distress.

Answer:  A

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual

 

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

  1. A) Airlines
  2. B) Computer software
  3. C) Biotechnology
  4. D) Electric utilities

Answer:  D

Diff: 1

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual

 

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

  1. A) Grocery store
  2. B) Semiconductors
  3. C) Real estate
  4. D) Utilities

Answer:  B

Diff: 1

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Conceptual


Use the information for the question(s) below.

 

Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding.  Suppose that Big Blue Banana announces plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.

 

11) Assuming perfect capital markets, the share price for BBB after this announcement is closest to:

  1. A) $11.40
  2. B) $10.85
  3. C) $10.00
  4. D) $8.60

Answer:  C

Explanation:  C) In perfect capital markets, VL = VU so even with the announcement of the increase in leverage the stock price won't change.

Diff: 1

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

12) Suppose that BBB pays corporate taxes of 35% and that shareholders expects the change in debt to be permanent.  Assuming that capital markets are perfect except for the existence of corporate taxes, the share price for BBB after this announcement is closest to:

  1. A) $10.00
  2. B) $10.85
  3. C) $8.60
  4. D) $11.40

Answer:  D

Explanation:  D) VU = $10.00 × 25 million shares = $250 million

VL = VU + τcB = $250 + .35($100) = $285 million/25 million shares = $11.40

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

13) Suppose that BBB pays corporate taxes of 35% and that shareholders expects the change in debt to be permanent.  Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs.  If the price of BBB's stock rises to $10.85 per share following the announcement, then the present value of BBB's financial distress costs is closest to:

  1. A) $21.25 million
  2. B) $35.00 million
  3. C) $11.40 million
  4. D) $13.75 million

Answer:  D

Explanation:  D) VU = $10.00 × 25 million shares = $250 million

VL = VU + τcB = $250 + .35($100) = $285 million/25 million shares = $11.40

PV of financial distress costs = ($11.40 - $10.85) × 25 million shares = $13.75 million

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

Use the information for the question(s) below.

 

Luther Industries has no debt and expects to generate free cash flows of $48 million each year.  Luther believes that if it permanently increases its level of debt to $100 million, the risk of financial distress may cause it to lose some customers and receive less favorable terms from its suppliers.  As a result, Luther's expected free cash flows with debt will be only $44 million per year.  Suppose Luther's tax rate is 40%, the risk-free rate is 6%, the expected return of the market is 14%, and the beta of Luther's free cash flows is 1.25 (with or without leverage).

 

14) The value of Luther without leverage is closest to:

  1. A) $315 million
  2. B) $300 million
  3. C) $205 million
  4. D) $340 million

Answer:  B

Explanation:  B) RE = rf + β(rM - rf) = .06 + 1.25(.14 - .06) = .16

VU =  =  = $300 million

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

15) The value of Luther with leverage is closest to:

  1. A) $315 million
  2. B) $340 million
  3. C) $205 million
  4. D) $300 million

Answer:  A

Explanation:  A) RE = rf - β(rM - rf) = .06 + 1.25(.14 - .06) = .16

VU =  =  = $275 million (using lower cash flow from leverage)

VL = VU + τcD = $275 + .4($100) = $315

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical


Use the information for the question(s) below.

 

Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding.  Suppose that Big Blue Banana announces plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.

 

16) Suppose that BBB pays corporate taxes of 40% and that shareholders expects the change in debt to be permanent.  Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs.  If the price of BBB's stock rises to $10.80 per share following the announcement, then the present value of BBB's financial distress costs is closest to:

Answer:  VU = $10.00 × 25 million shares = $250 million

VL = VU + τcB = $250 + .40($100) = $290 million/25 million shares = $11.60

 

PV of financial distress costs = ($11.60 - $10.80) × 25 million shares = $20 million

Diff: 2

Section:  16.4 Optimal Capital Structure: The Tradeoff Theory

Skill:  Analytical

 

16.5   Exploiting Debt Holders: The Agency Costs of Leverage

 

Use the following information to answer the question(s) below.

 

Nielson Motors has a debt-equity ratio of 1.8, an equity beta of 1.6, and a debt beta of 0.20. It is currently evaluating the following projects, none of which would change Nielson's volatility.

 

Project

1

2

3

4

5

Investment

100

75

120

60

80

NPV

23

12

18

15

14

(All amounts are in $millions.)

 

1) Nielson Motors should accept those projects with profitability ratios greater than:

  1. A) 0.15
  2. B) 0.175
  3. C) 0.20
  4. D) 0.225

Answer:  D

Explanation:  D) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

2) Which of the following projects should Nielson Motors accept?

  1. A) 1 only
  2. B) 1, 2, and 3 only
  3. C) 1 and 4 only
  4. D) 2, 3, and 5 only

Answer:  C

Explanation:  C) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

Project

1

2

3

4

5

Investment

100

75

120

60

80

NPV

23

12

18

15

14

 

 

 

 

 

 

PI(NPV/Invest)

0.23

0.16

0.15

0.25

0.175

 

Given the PIs above, only projects 1 and 4 are greater than .225.

Diff: 3

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

3) The total debt overhang associated with accepting project 1, is closest to:

  1. A) $0 million
  2. B) $12.5 million
  3. C) $14.4 million
  4. D) $22.5 million

Answer:  D

Explanation:  D) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

since PI = , then .225 =  → NPV = 22.5 million total debt overhang

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

4) The total debt overhang associated with accepting project 4, is closest to:

  1. A) $0 million
  2. B) $13.5 million
  3. C) $15.0 million
  4. D) $38.6 million

Answer:  B

Explanation:  B) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

since PI = , then .225 =  → NPV = 13.5 million total debt overhang

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

5) In order for Nielson Motor's to be willing to invest, project 5 must have an NPV greater than:

  1. A) $10.0 million
  2. B) $12.5 million
  3. C) $18.0 million
  4. D) $22.5 million

Answer:  C

Explanation:  C) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

since PI = , then .225 =  → NPV = 18.0 million

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

6) In order for Nielson Motor's to be willing to invest, project 3 must have an NPV greater than:

  1. A) $12.5 million
  2. B) $15.0 million
  3. C) $22.5 million
  4. D) $27.0 million

Answer:  D

Explanation:  D) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

since PI = , then .225 =  → NPV = 27.0 million

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

7) If Nielson Motors invests in only those projects which are beneficial to the stockholders, then the total debt overhang associated with accepting these project(s) is closest to:

  1. A) $22.5 million
  2. B) $36.0 million
  3. C) $38.0 million
  4. D) $57.5 million

Answer:  B

Explanation:  B) Equity holders will benefit from the new investment only when:

PI >  ×  =  × 1.8 = 0.125 × 1.8 = .225

Project

1

2

3

4

5

Investment

100

75

120

60

80

NPV

23

12

18

15

14

 

 

 

 

 

 

PI(NPV/Invest)

0.23

0.16

0.15

0.25

0.175

 

Given the PIs above, only projects 1 and 4 are greater than .225.

since PI = , then .225 =  

       → NPV = 22.5 million total debt overhang for project 1

since PI = , then .225 =  

       → NPV = 13.5 million total debt overhang for project 4

Total debt overhang = 22.5 + 13.5 = 36.0 million

Diff: 3

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

8) Which of the following statements is FALSE?

  1. A) When a firm faces financial distress, creditors can gain by making sufficiently risky investments, even if they have negative NPV.
  2. B) When a firm has leverage, a conflict of interest exists if investment decisions have different consequences for the value of equity and the value of debt.
  3. C) In some circumstances, managers may take actions that benefit shareholders but harm the firm's creditors and lower the total value of the firm.
  4. D) Agency costs are costs that arise when there are conflicts of interest between stakeholders.

Answer:  A

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Conceptual

 

9) Which of the following statements is FALSE?

  1. A) When a firm faces financial distress, shareholders have an incentive not to invest and to withdraw money from the firm if possible.
  2. B) Because top managers often hold shares in the firm and are hired and retained with the approval of the board of directors, which itself is elected by shareholders, managers will generally make decisions that increase the value of the firm's equity.
  3. C) An over-investment problem occurs when shareholders have an incentive to invest in risky positive-NPV projects.
  4. D) A negative-NPV project destroys value for the firm overall.

Answer:  C

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Conceptual

 

10) Which of the following statements is FALSE?

  1. A) The agency costs of debt can arise only if there is no chance the firm will default and impose losses on its debt holders.
  2. B) Agency costs represent another cost of increasing the firm's leverage that will affect the firm's optimal capital structure choice.
  3. C) An under-investment problem occurs when shareholders choose to not invest in a positive-NPV project.
  4. D) When a firm faces financial distress, it may choose not to finance new, positive-NPV projects.

Answer:  A

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Conceptual

 

11) Which of the following statements is FALSE?

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

Answer:  C

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Conceptual


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, but if the strategy fails the assets will be worth only $5 million.

 

12) What is the overall expected payoff under JR's new riskier business strategy?

  1. A) $4 million
  2. B) $11 million
  3. C) $20 million
  4. D) $15 million

Answer:  D

Explanation:  D) Expected payoff = (.4)$30 + (.6)$5 = $15 million

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

13) What is the expected payoff to debt holders under JR's new riskier business strategy?

  1. A) $20 million
  2. B) $4 million
  3. C) $15 million
  4. D) $11 million

Answer:  D

Explanation:  D) Expected payoff = (.4)$20 + (.6)$5 = $11 million

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

14) What is the expected payoff to equity holders under JR's new riskier business strategy?

  1. A) $15 million
  2. B) $11 million
  3. C) $20 million
  4. D) $4 million

Answer:  D

Explanation:  D) Expected payoff = (.4)$10 + (.6)$0 = $4 million

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical


Use the information for the question(s) below.

 

Wildcat Drilling is an oil and gas exploration company that is currently operating two active oil fields with a market value of $200 million each.  Unfortunately, Wildcat Drilling has $500 million in debt coming due at the end of the year.  A large oil company has offered Wildcat drilling a highly speculative, but potentially very valuable, oil and gas lease in exchange for one of their active oil fields.  If Wildcat accepts the trade, there is a 10% chance that Wildcat will discover a major new oil field that would be worth $1.2 billion, a 15% that Wildcat will discover a productive oil field that would be worth $600 million, and a 75% chance that Wildcat will not discover oil at all.

 

15) What is the overall expected payoff to Wildcat from the speculative oil lease deal?

  1. A) $360 million
  2. B) $275 million
  3. C) $85 million
  4. D) $160 million

Answer:  A

Explanation:  A) Expected payoff = (.1)($1200 ) + (.15)($600) + (.75)($200) = $360 million

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

16) What is the expected payoff to debt holders with the speculative oil lease deal?

  1. A) $10 million
  2. B) $275 million
  3. C) $85 million
  4. D) $160 million

Answer:  B

Explanation:  B) Expected payoff = (.1)($500) + (.15)($500) + (.75)($200) = $275 million

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

17) What is the expected payoff to equity holders with the speculative oil lease deal?

  1. A) $10 million
  2. B) $160 million
  3. C) $275 million
  4. D) $85 million

Answer:  D

Explanation:  D) Expected payoff = (.1)($1200 - $500) + (.15)($600 - $500) + (.75)($0) = $85 million

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

18) A type of agency problem that results in shareholders gaining from decisions that increase the risk of the firm sufficiently, even if they have negative NPV is:

  1. A) asset substitution.
  2. B) debt overhang.
  3. C) underinvestment.
  4. D) cashing out.

Answer:  A

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

19) A type of agency problem that results in shareholders gaining by choosing not to finance new, positive-NPV projects is:

  1. A) asset substitution.
  2. B) debt overhang.
  3. C) excessive risk-taking.
  4. D) distress costs.

Answer:  B

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

20) In an agency problem known as asset substitution, the agency cost is paid by:

  1. A) the debt holders, since if the risky project is not successful debt holders will lose all their money.
  2. B) the debt holders, since if the risky project is successful debt holders will receive less money.
  3. C) the equity holders, since the strategy has a negative expected payoff.
  4. D) the equity holders, since they will lose all their money whether or not the project is successful.

Answer:  A

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

21) In an agency problem known as debt overhang, if the company has risky debt outstanding, equity holders will choose to invest only if:

  1. A) the NPV of the project exceeds a cutoff equal to the relative riskiness of the firm's debt times its debt-equity ratio.
  2. B) the profitability index of the project exceeds a cutoff equal to the relative riskiness of the firm's debt times its debt-equity ratio.
  3. C) the NPV of the project is negative.
  4. D) the debt holders will lose all their money.

Answer:  B

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

22) The cost of ________ is highest for firms that are likely to have profitable future growth opportunities requiring large investments.

  1. A) asset substitution
  2. B) debt overhang
  3. C) debt covenants
  4. D) debt maturity

Answer:  B

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

23) The cost of ________ is highest for firms that can easily increase the risk of their investments.

  1. A) asset substitution
  2. B) debt overhang
  3. C) debt covenants
  4. D) debt maturity

Answer:  A

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

24) The term moral hazard refers to:

  1. A) the chance the firm will default and impose losses on its debtholders.
  2. B) the under-investment problem.
  3. C) the over-investment problem.
  4. D) the idea that individuals will change their behavior if they are not fully exposed to its consequences.

Answer:  D

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

25) Which of the following agency problems represents a form of moral hazard?

  1. A) asset substitution
  2. B) debt overhang
  3. C) cashing out
  4. D) All of the above are examples of moral hazard.

Answer:  D

Diff: 1

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Definition

 

26) Which of the following is one unintended consequence of the federal bailouts in response to the 2008 financial crisis?

  1. A) Bondholders will charge equity holders for the risk of this abuse.
  2. B) Equity holders will credibly commit not to take excessive risk by agreeing to very strong bond covenants.
  3. C) Lenders to corporations considered "too big to fail" may presume they have an implicit government guarantee, thus lowering their incentives to insist on strong covenants.
  4. D) Managers who earned large bonuses when their businesses did well did not need to repay those bonuses later when things turned sour.

Answer:  C

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Conceptual

 

27) Rose Industries has a $20 million loan due at the end of the year and its assets will have a market value of only $15 million when the loan comes due.  Currently Rose has $2 million in cash.  Rose is considering two possible alternative uses for this cash.  One possibility is to pay the $2 million out to shareholders in the form of a special dividend.  The second possibility is to invest the $2 million into a project that offers a $4 million NPV.  What are the payoffs to the debt and equity holders under each of the two alternatives?  Which alternative would equity holders prefer?  Which alternative would debt holders prefer?  What is the economic term that describes this situation?

Answer:  Case #1 Pay special dividend

 

Payoff to equity holders = $2 million

Payoff to debt holders = $15 million - $2 million = $13 million

 

Case #2 Invest in Positive NPV project

 

Payoff to equity holders = $0

Payoff to debt holders = $15 million + $4 million = $19 million

 

So debt holders prefer +NPV project and equity holders prefer special dividend.

 

This is an under investment problem, where a firm does not engage in a +NPV project because of agency costs between shareholders and debt holders.

Diff: 2

Section:  16.5 Exploiting Debt Holders: The Agency Costs of Leverage

Skill:  Analytical

 

16.6   Motivating Managers: The Agency Benefits of Leverage

 

1) Which of the following statements is FALSE?

  1. A) One disadvantage of using leverage is that it does not allow the original owners of the firm to maintain their equity stake.
  2. B) The separation of ownership and control creates the possibility of management entrenchment; facing little threat of being fired and replaced, managers are free to run the firm in their own best interests.
  3. C) Managers also have their own personal interests, which may differ from those of both equity holders and debt holders.
  4. D) The costs of reduced effort and excessive spending on perks are another form of agency cost.

Answer:  A

Diff: 1

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Conceptual

 

2) Which of the following statements is FALSE?

  1. A) A serious concern for large corporations is that managers may make large, unprofitable investments.
  2. B) While overspending on personal perks may be a problem for large firms, these costs are likely to be small relative to the overall value of the firm.
  3. C) Some financial economists explain a manager's willingness to engage in negative-NPV investments as empire building.
  4. D) While ownership is often diluted for small, young firms, ownership typically becomes concentrated over time as a firm grows.

Answer:  D

Diff: 1

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Conceptual

 

3) Which of the following statements is FALSE?

  1. A) Leverage can reduce the degree of managerial entrenchment because managers are more likely to be fired when a firm faces financial distress.
  2. B) When a firm is highly levered, creditors themselves will closely monitor the actions of managers, providing an additional layer of management oversight.
  3. C) According to the empire building hypothesis, leverage increases firm value because it commits the firm to making future interest payments, thereby reducing excess cash flows and wasteful investment by managers.
  4. D) Managers of large firms tend to earn higher salaries, and they may also have more prestige and garner greater publicity than managers of small firms. As a result, managers may expand (or fail to shut down) unprofitable divisions, pay too much for acquisitions, make unnecessary capital expenditures, or hire unnecessary employees.

Answer:  C

Diff: 2

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Conceptual


Use the information for the question(s) below.

 

You own your own firm and you need to raise $50 million to fund an expansion.  Following the expansion, your firm will be worth $75 million in its unlevered form.  You want to go ahead with the expansion, but you are concerned that you may not be able to maintain ownership of over 50% of your firm's equity.  In other words, you are concerned that if you use equity to finance the expansion, you may lose control of your firm.

 

4) Assume that capital markets are perfect, you issue $30 million in new debt, and you issue $20 million in new equity.  You ownership stake in the firm following these new issues of debt and equity is closest to:

  1. A) 58%
  2. B) 50%
  3. C) 33%
  4. D) 55%

Answer:  D

Explanation:  D) Owner's equity = value - debt - new equity = 75 - 30 - 20 = $25 million

Total equity = owners equity + new equity = $25 + $20 = $45 million

Owner's stake =  = .555555 or 55.56%

Diff: 1

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Analytical

 

5) Assume that capital markets are perfect, you issue $25 million in new debt, and you issue $25 million in new equity.  Your ownership stake in the firm following these new issues of debt and equity is closest to:

  1. A) 50%
  2. B) 55%
  3. C) 58%
  4. D) 33%

Answer:  A

Explanation:  A) Owner's equity = value - debt - new equity = 75 - 25 - 25 = $25 million

Total equity = owners equity + new equity = $25 + $25 = $50 million

Owner's stake =  = .50 or 50.0%

Diff: 1

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Analytical

 

6) Assume that capital markets are perfect except for the existence of corporate taxes.  Your firm pays 40% of earnings in taxes and you decide to issue $25 million in new debt and $25 million in new equity.  Your ownership stake in the firm following these new issues of debt and equity is closest to:

  1. A) 58%
  2. B) 55%
  3. C) 33%
  4. D) 50%

Answer:  A

Explanation:  A) VU = $75 million

VL = VU + τcD = $75 + .40($25) = $85 million

 

Owner's equity = value - debt - new equity = 85 - 25 - 25 = $35 million

Total equity = owners equity + new equity = $35 + $25 = $60 million

Owner's stake =  = .5833 or 58.33%

Diff: 2

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Analytical

 

7) Assume that capital markets are perfect except for the existence of corporate taxes and that your firm pays 40% of earnings in taxes.  If you want to maintain ownership of at least a 50%, then the minimum amount of debt that you must issue to fund the expansion is closest to:

  1. A) $19 million
  2. B) $18 million
  3. C) $16 million
  4. D) $20 million

Answer:  B

Explanation:  B) VU = $75 million

% Ownership =

Given:

VL = VU + τcD

new equity = $50 million needed for expansion - the amount of new debt:

 

% Ownership =

% Ownership =  = .50 (given we want 50% ownership)

$25 + .4(debt) = .50($75 - .6(debt))

50 + 1.4(debt) = 75

Debt =  = $17.857 million

Diff: 3

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Analytical

 

8) Assume that capital markets are perfect except for the existence of corporate taxes and that your firm pays 35% of earnings in taxes.  If you want to maintain ownership of at least a 50%, then calculate the minimum amount of debt that you must issue to fund the expansion.

Answer:  VU = $75 million

% Ownership =

Given:

VL = VU + τcD

New equity = $50 million needed for expansion - the amount of new debt:

 

% Ownership =

% Ownership =  = .50 (given we want 50% ownership)

$25 + .35(debt) = .50($75 - .65(debt))

50 + 1.35(debt) = 75

Debt =  = $18.52 million

Diff: 3

Section:  16.6 Motivating Managers: The Agency Benefits of Leverage

Skill:  Analytical

 

 

16.7   Agency Costs and the Trade-off Theory

 

Use the following information to answer the question(s) below.

 

If managed effectively, Rearden Metal will have assets with a market value of $200 million, $300 million, or $400 million next year, with each outcome being equally likely. Managers, however, may decided to engage in wasteful empire building, which will reduce Rearden'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%, 5%, and 45% respectively.

 

1) What is the expected value of Rearden's assets if it were run efficiently?

  1. A) $265 million
  2. B) $280 million
  3. C) $295 million
  4. D) $300 million

Answer:  D

Explanation:  D) The expected value is just the weighted average of the possible outcomes.

E[assets] = ($200) + ($300) + ($400) = $300 million

Diff: 1

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

2) Suppose that the managers at Rearden Metal will engage in empire building unless that behavior increases the likelihood of bankruptcy. If Rearden has $180 million in debt due in one year, then the expected value of Rearden's assets is closest to:

  1. A) $265 million
  2. B) $280 million
  3. C) $295 million
  4. D) $300 million

Answer:  B

Explanation:  B) In all cases Rearden will be able to pay off its debt and avoid bankruptcy if it engages in empire building, even in the worse case they will have $200 million - $20 million = $180 million in assets. 

The expected value is just the weighted average of the possible outcomes.

E[assets] = ($200 - $20) + ($300 - $20) + ($400 - $20) = $280 million

Diff: 2

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

 

 

3) Suppose that the managers at Rearden Metal will engage in empire building unless that behavior increases the likelihood of bankruptcy. If Rearden has $190 million in debt due in one year, then the expected value of Rearden's assets is closest to:

  1. A) $265 million
  2. B) $280 million
  3. C) $295 million
  4. D) $300 million

Answer:  D

Explanation:  D) In this case the probability of bankruptcy is increased, since in the event of the worse outcome with empire building Rearden's assets would only be worth $200 - $20 = $180 million which will not cover the repayment of debt. Therefore the management team will not engage in empire building.

The expected value is just the weighted average of the possible outcomes.

E[assets] = ($200) + ($300) + ($400) = $300 million

Diff: 2

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

4) Suppose that the managers at Rearden Metal will increase risk to maximize the expected payoff to equity holders. If Rearden has $180 million in debt due in one year, then the expected value of Rearden's assets is closest to:

  1. A) $280 million
  2. B) $295 million
  3. C) $300 million
  4. D) $900 million

Answer:  C

Explanation:  C) Expected Payoff to equity holders w/o increase in risk:

E[equity] = ($200 - $180) + ($300 - $180) + ($400 - $180) = $120 million

Expected Payoff to equity holders w/increase in risk:

E[equity] = (50%)($200 - $180) + (5%)($300 - $180) + (45%)($400 - $180) = $115 million

 

Therefore Rearden's managers will not increase the risk and the expected value of Rearden's assets is:

E[assets] = ($200) + ($300) + ($400) = $300 million

Diff: 3

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

 

 

 

5) Suppose that the managers at Rearden Metal will increase risk to maximize the expected payoff to equity holders. If Rearden has $230 million in debt due in one year, then the expected value of Rearden's assets are closest to:

  1. A) $280 million
  2. B) $295 million
  3. C) $300 million
  4. D) $900 million

Answer:  B

Explanation:  B) Expected Payoff to equity holders w/o increase in risk:

E[equity] = ($200 - $200) + ($300 - $230) + ($400 - $230) = $70 million

Expected Payoff to equity holders w/increase in risk:

E[equity] = (50%)($200 - $200) + (5%)($300 - $230) + (45%)($400 - $230) = $80 million

 

Therefore Rearden's managers will increase the risk and the expected value of Rearden's assets is:

E[assets] = (50%)($200) + (5%)($300) + (45%)($400) = $295 million

Diff: 3

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

6) Which of the following statements is FALSE?

  1. A) The optimal level of debt D*, balances the costs and benefits of leverage.
  2. B) As the debt level increases, the firm benefits from the interest tax shield (which has present value τ*D).
  3. C) If the debt level is too large firm value is reduced due to the loss of tax benefits (when interest exceeds EBIT), financial distress costs, and the agency costs of leverage.
  4. D) As the debt level increases, the firm faces worse incentives for management, which increase wasteful investment and perks.

Answer:  D

Diff: 1

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Conceptual

 

7) Which of the following statements is FALSE?

  1. A) Firms with high R&D costs and future growth opportunities typically maintain high debt levels.
  2. B) The tradeoff theory explains how firms should choose their capital structures to maximize value to current shareholders.
  3. C) With tangible assets, the financial distress costs of leverage are likely to be low, as the assets can be liquidated for close to their full value.
  4. D) Proponents of the management entrenchment theory of capital structure believe that managers choose a capital structure to avoid the discipline of debt and maintain their own job security.

Answer:  A

Diff: 2

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Conceptual

 

 

8) Which of the following firms is likely to maintain low levels of debt?

  1. A) An electric utility
  2. B) A tobacco company
  3. C) An Internet firm
  4. D) A mature restaurant chain

Answer:  C

Diff: 1

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Conceptual

Use the information for the question(s) below.

 

If it is managed efficiently, Luther industries will have assets with 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.

 

9) If it is managed efficiently, then the expected market value of Luther's assets is closest to:

  1. A) $300 million
  2. B) $260
  3. C) $240
  4. D) $280 million

Answer:  A

Explanation:  A) Expected value =  = $300 million

Diff: 1

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

 

10) If its managers engage in empire building, then the expected market value of Luther's assets is closest to:

  1. A) $260
  2. B) $280 million
  3. C) $240
  4. D) $300 million

Answer:  B

Explanation:  B) Expected value =  = $280 million

Diff: 1

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

 

 

11) If its managers increase the risk of the firm, then the expected market value of Luther's assets is closest to:

  1. A) $260
  2. B) $240
  3. C) $300 million
  4. D) $280 million

Answer:  A

Explanation:  A) Expected value = .5(100) + .2(300) + .3(500) = $260 million

Diff: 1

Section:  16.7 Agency Costs and the Tradeoff Theory

Skill:  Analytical

16.8   Asymmetric Information and Capital Structure

 

1) The idea that managers who perceive the firm's equity is under-priced will have a preference to fund investment using retained earnings, or debt, rather than equity is known as the:

  1. A) signaling theory of debt.
  2. B) lemons principle.
  3. C) pecking order hypothesis.
  4. D) credibility principle.

Answer:  C

Diff: 1

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Definition

 

2) The idea that claims in one's self-interest are credible only if they are supported by actions that would be too costly to take if the claims were untrue is known as the:

  1. A) pecking order hypothesis.
  2. B) credibility principle.
  3. C) lemons principle.
  4. D) signaling theory of debt.

Answer:  B

Diff: 1

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Definition

 

3) 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:

  1. A) pecking order hypothesis.
  2. B) signaling theory of debt.
  3. C) lemons principle.
  4. D) credibility principle.

Answer:  C

Diff: 1

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Definition


Use the information for the question(s) below.

 

Electronic Gaming Incorporated (EGI) is a firm with no debt and its 20 million shares are currently trading for $16 per share.  Based on the prospects for EGI's new hand held video game, management feels the true value of the firm is $20 per share.  Management believes that the share price will reflect this higher value after the video game is released next fall.  EGI has already announced plans to raise $100 million from investors to build a new factory.

 

4) Assume that EGI decides to raise the $100 million through the issuance of new shares prior to the release of the new video game.  The number of new shares that EGI will issue is closest to:

  1. A) 5.0 million
  2. B) 6.25 million
  3. C) 10 million
  4. D) 1.6 million

Answer:  B

Explanation:  B) shares =  = 6,250,000 new shares

Diff: 1

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Analytical

 

5) Assume that EGI decides to wait until after the release of the new video game before they raise the $100 million through the issuance of new shares.  The number of new shares that EGI will issue is closest to:

  1. A) 1.6 million
  2. B) 5.0 million
  3. C) 10 million
  4. D) 6.25 million

Answer:  B

Explanation:  B) shares =  = 5,000,000 new shares

Diff: 1

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Analytical

 

6) Assume that EGI decides to raise the $100 million through the issuance of new shares prior to the release of the new video game.  EGI's share price following the release of the new video game will be closest to:

  1. A) $18.00
  2. B) $19.00
  3. C) $20.00
  4. D) $16.00

Answer:  B

Explanation:  B) shares =  = 6,250,000 new shares

 

Total shares = 20M (existing) + 6.25M new = 26.25 million.

 

Total Value = existing value + $100M new factory

Total Value = $20 per share (true value) × 20 million shares + $100 = $500 million

 

Price per share =  = $19.05

Diff: 2

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Analytical

 

7) Assume that EGI decides to wait until after the release of the new video game before they raise the $100 million through the issuance of new shares.  EGI's share price following the release of the new video game will be closest to:

  1. A) $18.00
  2. B) $20.00
  3. C) $16.00
  4. D) $19.00

Answer:  B

Explanation:  B) shares =  = 5M new shares

 

Total shares = 20M (existing) + 5M new = 25 million.

 

Total value = existing value + $100M new factory

Total value = $20 per share (true value) × 20 million shares + $100 = $500 million

 

Price per share =  = $20.00

Diff: 2

Section:  16.8 Asymmetric Information and Capital Structure

Skill:  Analytical

 

16.9   Capital Structure: The Bottom Line

 

1) Which of the following statements is FALSE?

  1. 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.
  2. B) When agency costs are significant, short-term debt may be the most attractive form of external financing.
  3. C) Too much debt can motivate managers and equity holders to take excessive risks or over-invest in a firm.
  4. D) Of all the different possible imperfections that drive capital structure, the most clear-cut, and possibly the most significant, is taxes.

Answer:  C

Diff: 1

Section:  16.9 Capital Structure: The Bottom Line

Skill:  Conceptual

 

2) Which of the following influences a firm's choice of capital structure?

  1. A) Taxes
  2. B) Agency costs and benefits of leverage
  3. C) Signaling and adverse selection
  4. D) All of the above influence capital structure decisions.

Answer:  D

Diff: 1

Section:  16.9 Capital Structure: The Bottom Line

Skill:  Analytical

 

3) Which of the following is unlikely to influence a firm's choice of capital structure?

  1. A) Taxes
  2. B) Agency costs and benefits of leverage
  3. C) Transaction costs
  4. D) All of the above influence capital structure decisions.

Answer:  C

Diff: 2

Section:  16.9 Capital Structure: The Bottom Line

Skill:  Conceptual

 

 

 

 

 

 

 

 

 

 

 -----

Key Contents: Financial Management and Corporate Finance
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Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business, University of Western Ontario
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown
International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick, Columbia University
------
Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University, Jarrad Harford, University of Washington

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Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, Virginia Polytechnic Instit. and State University
Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
------
Part 1: Fundamental Concepts and Basic Tools of Finance
1. Financial Management
2. Financial Statements
3. The Time Value of Money (Part 1)
4. The Time Value of Money (Part 2)
5. Interest Rates
Part 2: Valuing Stocks and Bonds and Understanding Risk and Return
6. Financial Management Bonds and Bond Valuation
7. Stocks and Stock Valuation
8. Risk and Return
Part 3: Capital Budgeting
9: Capital Budgeting Decision Models
10: Cash Flow Estimation
11: The Cost of Capital
Part 4: Financial Planning and Evaluating Performance
12. Forecasting and Short-Term Financial Planning
13. Working Capital Management
14. Financial Ratios and Firm Performance
Part 5: Other Selected Finance Topics
15. Raising Capital
16. Capital Structure
17. Dividends, Dividend Policy, and Stock Splits
18. International Financial Management
Appendix 1 Future Value Interest Factors
Appendix 2 Present Value Interest Factors
Appendix 3 Future Value Interest Factors of an Annuity
Appendix 4 Present Value Interest Factors of an Annuity
Appendix 5 Answers to Prepping for Exam Questions
------
1. Overview of Financial Management
2. Sizing Up a Business: A Non-Financial Perspective
3. Understanding Financial Statements
4. Measuring Financial Performance
5. Managing Day-To-Day Cash Flow
6. Projecting Financial Requirements and Managing Growth
7. Time Value of Money Basics and Applications
8. Making Investment Decisions
9. Overview of Capital Markets: Long-Term Financing Instruments
10. Assessing the Cost of Capital: What Investors Require
11. Understanding Financing and Payout Decisions
12. Designing an Optimal Capital Structure
13. Measuring and Creating Value
14. Comprehensive Case Study: Wal-Mart Stores, Inc.

1. Overview of Financial Management
• 1.1: Financial Management and the Cash Flow Cycle
• 1.2: The Role of Financial Managers
• 1.3: A Non-Financial Perspective of Financial Management
• 1.4: Financial Management’s Relationship with Accounting and Other Disciplines
• 1.5: Types of Firms
• 1.6: A Financial Management Framework
• 1.7: Relevance for Managers
• 1.8: Summary
• 1.9: Additional Readings
• 1.10: End of Chapter Problems
2. Sizing Up a Business: A Non-Financial Perspective
• 2.1: Sizing Up The Overall Economy
o 2.1.1: GDP Components
o 2.1.2: Sector-Related Fluctuations
o 2.1.3: Inflation and Interest Rates
o 2.1.4: Capital Markets
o 2.1.5: Economic Size-Up Checklist
• 2.2: Sizing Up the Industry
o 2.2.1: Industry Life Cycles
o 2.2.2: The Competitive Environment
o 2.2.3: Opportunities and Risks
o 2.2.4: Industry Size-up Checklist
• 2.3: Sizing Up Operations Management and Supply Risk
• 2.4: Sizing Up Marketing Management and Demand Risk
• 2.5: Sizing Up Human Resource Management and Strategy
• 2.6: Sizing Up Home Depot: An Example
• 2.7: Relevance for Managers
• 2.8 Summary
• 2.9: Additional Readings and Information
• 2.10: End of Chapter Problems
3. Understanding Financial Statements
• 3.1: Understanding Balance Sheets
o 3.1.1: Understanding Assets
o 3.1.2: Understanding Liabilities
o 3.1.3: Understanding Equity
• 3.2: Understanding Income Statements
o 3.2.1: Understanding Revenues, Costs, Expenses, and Profits
o 3.2.2: Connecting a Firm’s Income Statement and Balance Sheet
• 3.3: Understanding Cash Flow Statements
o 3.3.1: Cash Flows Related to Operating Activities
o 3.3.2: Cash Flows from Investing Activities
o 3.3.3: Cash Flows from Financing Activities
• 3.4: Relevance for Managers
• 3.5: Summary
• 3.6: Additional Readings and Sources of Information
• 3.7: End of Chapter Problems
4. Measuring Financial Performance
• 4.1: Performance Measures
o 4.1.1: Return on Equity
o 4.1.2: Profitability Measures
o 4.1.3: Resource Management Measures
o 4.1.4: Liquidity Measures
o 4.1.5: Leverage Measures
o 4.1.6: Application: Home Depot
• 4.2: Reading Annual Reports
• 4.3: Relevance for Managers
• 4.4: Summary
• 4.5: Additional Readings and Sources of Information
• 4.6: End of Chapter Problems
5. Managing Day-To-Day Cash Flow
• 5.1: Cash Flow Cycles
• 5.2: Working Capital Management
o 5.2.1: Managing Inventory
o 5.2.2: Managing Accounts Receivable
o 5.2.3: Managing Accounts Payable
o 5.2.4: Application: Home Depot
• 5.2.4.1: Orange Computers and Little Orange Computers
• 5.2.4.2: Home Depot
• 5.3: Short-Term Financing
o 5.3.1: Bank Loans
o 5.3.2: Commercial Paper
o 5.3.3: Banker’s Acceptance
• 5.4: Relevance for Managers
• 5.5: Summary
• 5.6: Additional Readings
• 5.7: End of Chapter Problems

6. Projecting Financial Requirements and Managing Growth
• 6.1: Generating Pro Forma Income Statements
o 6.1.1: Establishing the Cost of Goods Sold and Gross Profit
o 6.1.2: Establishing Expenses
o 6.1.3: Establishing Earnings
• 6.2: Generating Pro Forma Balance Sheets
o 6.2.1: Establishing Assets
o 6.2.2: Establishing Liabilities and Equity
• 6.3: Generating Pro Forma Cash Budgets
o 6.3.1: Establishing Cash Inflows
o 6.3.2: Establishing Cash Outflows
o 6.3.3: Establishing Net Cash Flows
• 6.4: Performing Sensitivity Analysis
o 6.4.1: Sales Sensitivity
o 6.4.1: Interest Rate Sensitivity
o 6.4.3: Working Capital Sensitivity
• 6.5: Understanding Sustainable Growth and Managing Growth
• 6.6: Relevance for Managers
• 6.7: Summary
• 6.8: Additional Readings and Resources
• 6.9: Problems

7. Time Value of Money Basics and Applications
• 7.1: Exploring Time Value of Money Concepts
o 7.1.1: Future Values
o 7.1.2: Present Values
o 7.1.3: Annuities
o 7.1.4: Perpetuities
• 7.2: Applying Time Value of Money Concepts to Financial Securities
o 7.2.1: Bonds
o 7.2.2: Preferred Shares
o 7.2.3: Common Equity
• 7.3: Relevance for Managers
• 7.4: Summary
• 7.5: Additional Readings
• 7.6: End of Chapter Problems

8. Making Investment Decisions
• 8.1: Understanding the Decision-Making Process
• 8.2: Capital Budgeting Techniques
o 8.2.1: Payback
• 8.2.1.1: Strengths and Weaknesses of the Payback Method
o 8.2.2: Net Present Value
• 8.2.2.1: Strengths and Weaknesses of the Net Present Value Method
o 8.2.3: Internal Rate of Return
• 8.2.3.1: Strengths and Weaknesses of the Internal Rate of Return Method
• 8.2.3.2: Modified Internal Rate of Return
• 8.3: Capital Budgeting Extensions
o 8.3.1: Profitability Index
o 8.3.2: Equivalent Annual Cost and Project Lengths
o 8.3.3: Mutually Exclusive Projects and Capital Rationing
• 8.4: Relevance for Managers
• 8.5: Summary
• 8.6: Additional Readings
• 8.7: End of Chapter Problems

9. Overview of Capital Markets: Long-Term Financing Instruments
• 9.1: Bonds
o 9.1.1: Changing Bond Yields
o 9.1.2: Bond Features
o 9.1.3: Bond Ratings
• 9.2: Preferred Shares
• 9.3: Common Shares
o 9.3.1: Historical Returns
• 9.4: Capital Markets Overview
o 9.4.1: Private versus Public Markets
o 9.4.2: Venture Capital and Private Equity
o 9.4.3: Initial Offerings versus Seasoned Issues
o 9.4.4: Organized Exchanges versus Over-The-Counter Markets
o 9.4.5: Role of Intermediaries
• 9.5: Market Efficiency
o 9.5.1: Weak Form
o 9.5.2: Semi-strong Form
o 9.5.3: Strong Form
o 9.5.4: U.S. Stock Market Efficiency
• 9.6: Relevance for Managers
• Appendix: Understanding Bond and Stock Investment Information
• 9.7: Summary
• 9.8: Additional Readings
• 9.9: End of Chapter Problems

10. Assessing the Cost of Capital: What Investors Require
• 10.1: Understanding the Cost of Capital: An Example
• 10.2: Understanding the Implications of the Cost of Capital
• 10.3: Defining Risk
• 10.4: Estimating the Cost of Debt
• 10.5: Estimating the Cost of Preferred Shares
• 10.6: Estimating the Cost of Equity
o 10.6.1: Dividend Model Approach
o 10.6.2: Capital Asset Pricing Model
• 10.6.2.1: Risk-Free Rate
• 10.6.2.2: Market Risk Premium
• 10.6.2.3: Beta
• 10.7: Estimating Component Weights
• 10.8: Home Depot Application
• 10.9: Hurdle Rates
• 10.10: Relevance for Managers
• 10.11: Summary
• 10.12: Additional Readings
• 10.13: Problems
11. Understanding Financing and Payout Decisions
• 11.1: Capital Structure Overview
• 11.2: Understanding the Modigliani-Miller Argument: Why Capital Structure Does Not Matter
• 11.3: Relaxing the Assumptions: Why Capital Structure Does Matter
o 11.3.1: Understanding the Impact of Corporate Taxes
o 11.3.2: Understanding the Impact of Financial Distress
o 11.3.3: Combining Corporate Taxes and Financial Distress Costs
o 11.3.4: Impact of Asymmetric Information
• 11.4: Understanding Payout Policies
o 11.4.1: Paying Dividends
o 11.4.2: Repurchasing Shares
o 11.4.3: Do Dividend Policies Matter?
• 11.5: Relevance for Managers
• 11.6: Summary
• 11.7: Additional Resources
• 11.8: End of Chapter Problems
• Appendix: Why Dividend Policy Doesn’t Matter: Example

12. Designing an Optimal Capital Structure
• 12.1: Factor Affecting Financing Decisions: The FIRST Approach
o 12.1.1: Maximizing Flexibility
o 12.1.2: Impact on EPS: Minimizing Cost
• 12.1.2.1: A Simple Valuation Model
• 12.1.2.2: Earnings before Interest and Taxes Break-Even: What Leverage Really Means
• 12.1.2.3: Does Issuing Equity Dilute the Value of Existing Shares?
o 12.1.3: Minimizing Risk
o 12.1.4: Maintaining Shareholder Control
o 12.1.5: Optimal Training
• 12.2: Tradeoff Assessment: Evaluating FIRST Criteria
• 12.3: Relevance for Managers
• 12.4: Summary
• 12.5: Additional Resource
• 12.6: End of Chapter Problems

13. Measuring and Creating Value
• 13.1: An Overview of Measuring and Creating Value
• 13.2: Measuring Value: The Book Value Plus Adjustments Method
o 13.2.1: Pros and Cons of the Book Value of Equity Plus Adjustments Method
• 13.3: Measuring Value: The Discount Cash Flow Analysis Method
o 13.3.1: Estimating Free Cash Flows
o 13.3.2: Estimating the Cost of Capital
o 13.3.3: Estimating the Present Value of Free Cash Flows
o 13.3.4: Estimating the Terminal Value
o 13.3.5: Estimating the Value of Equity
o 13.3.6: Pros and Cons of the Free Cash Flow to the Firm Approach
• 13.4: Measuring Value: Relative Valuations and Comparable Analysis
o 13.4.1: The Price-Earnings Method
• 13.4.1.1: Pros and Cons of the Price-Earnings Approach
o 13.4.2: The Enterprise Value-to-EBITDA Method
• 13.4.2.1: Pros and Cons of the EV/EBITDA Approach
• 13.5: Creating Value and Value-Based Management
• 13.6: Valuing Mergers and Acquisitions
o 13.6.1: Valuing Comparable M&A Transactions
• 13.7: Relevance for Managers
• 13.8: Summary
• 13.9: Additional Readings
• 13.10: End of Chapter Problems

14. Comprehensive Case Study: Wal-Mart Stores, Inc.
• 14.1: Sizing Up Wal-Mart
o 14.1.1: Analyzing the Economy
o 14.1.2: Analyzing the Industry
o 14.1.3: Analyzing Walmart’s Strengths and Weaknesses in Operations, Marketing, Management, and Strategy
• 14.1.3.1: Analyzing Walmart’s Operations
• 14.1.3.2: Analyzing Walmart’s Marketing
• 14.1.3.3: Analyzing Walmart’s Management and Strategy
o 14.1.4: Analyzing Walmart’s Financial Health
• 14.2: Projecting Walmart’s Future Performance
o 14.2.1: Projecting Walmart’s Income Statement
o 14.2.2: Projecting Walmart’s Balance Sheet
o 14.2.3: Examining Alternate Scenarios
• 14.3: Assessing Walmart’s Long-Term Investing and Financing
o 14.3.1: Assessing Walmart’s Investments
o 14.3.2: Assessing Walmart’s Capital Raising and the Cost of Capital
• 14.4: Valuing Walmart
o 14.4.1: Measuring Walmart’s Economic Value Added
o 14.4.2: Estimating Walmart’s Intrinsic Value: The DCF Approach
o 14.4.3: Estimating Walmart’s Intrinsic Value: Comparable Analysis
o 14.4.4: Creating Value and Overall Assessment of Walmart
• 14.5: Relevance for Managers and Final Comments
• 14.6: Additional Readings and Sources of Information
• 14.7: End of Chapter Problems
------
Part 1: Introduction to Financial Management
Chapter 1: Getting Started - Principles of Finance
Chapter 2: Firms and the Financial Market
Chapter 3: Understanding Financial Statements, Taxes, and Cash Flows
Chapter 4: Financial Analysis - Sizing Up Firm Performance
Part 2: Valuation of Financial Assets
Chapter 5: Time Value of Money - The Basics
Chapter 6: The Time Value of Money - Annuities and Other Topics
Chapter 7: An Introduction to Risk and Return - History of Financial Market Returns
Chapter 8: Risk and Return - Capital Market Theory
Chapter 9: Debt Valuation and Interest Rates
Chapter 10: Stock Valuation
Part 3: Capital Budgeting
Chapter 11: Investment Decision Criteria
Chapter 12: Analyzing Project Cash Flows
Chapter 13: Risk Analysis and Project Evaluation
Chapter 14: The Cost of Capital
Part 4: Capital Structure & Dividend Policy
Chapter 15: Capital Structure Policy
Chapter 16: Dividend Policy
Part 5: Liquidity Management & Special Topics in Finance
Chapter 17: Financial Forecasting and Planning
Chapter 18: Working Capital Management
Chapter 19: International Business Finance
Chapter 20: Corporate Risk Management
------
PART I: INTRODUCTION TO FOREIGN EXCHANGE MARKETS AND RISKS
Chapter 1: Globalization and the Multinational Corporation
Chapter 2: The Foreign Exchange Market
Chapter 3: Forward Markets and Transaction Exchange Risk
Chapter 4: The Balance of Payments
Chapter 5: Exchange Rate Systems
PART II: INTERNATIONAL PARITY CONDITIONS AND EXCHANGE RATE DETERMINATION
Chapter 6: Interest Rate Parity
Chapter 7: Speculation and Risk in the Foreign Exchange Market
Chapter 8: Purchasing Power Parity and Real Exchange Rates
Chapter 9: Measuring and Managing Real Exchange Risk
Chapter 10: Exchange Rate Determination and Forecasting

PART III: INTERNATIONAL CAPITAL MARKETS
Chapter 11: International Debt Financing
Chapter 12: International Equity Financing
Chapter 13: International Capital Market Equilibrium
Chapter 14: Political and Country Risk

PART IV: INTERNATIONAL CORPORATE FINANCE
Chapter 15: International Capital Budgeting
Chapter 16: Additional Topics in International Capital Budgeting
Chapter 17: Risk Management and the Foreign Currency Hedging Decision
Chapter 18: Financing International Trade
Chapter 19: Managing Net Working Capital

PART V: FOREIGN CURRENCY DERIVATIVES
Chapter 20: Foreign Currency Futures and Options
Chapter 21: Interest Rate and Foreign Currency Swaps
------
PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
PART 7: OPTIONS
20. Financial Options
21. Option Valuation
22. Real Options

PART 8: LONG-TERM FINANCING
23. Raising Equity Capital
24. Debt Financing
25. Leasing
PART 9: SHORT-TERM FINANCING
26. Working Capital Management
27. Short-Term Financial Planning
PART 10: SPECIAL TOPICS
28. Mergers and Acquisitions
29. Corporate Governance
30. Risk Management
31. International Corporate Finance
------
PART 1: INTRODUCTION
1. The Corporation
2. Introduction to Financial Statement Analysis
3. Financial Decision Making and the Law of One Price
PART 2: TIME, MONEY, AND INTEREST RATES
4. The Time Value of Money
5. Interest Rates
6. Valuing Bonds
PART 3: VALUING PROJECTS AND FIRMS
7. Investment Decision Rules
8. Fundamentals of Capital Budgeting
9. Valuing Stocks
PART 4: RISK AND RETURN
10. Capital Markets and the Pricing of Risk
11. Optimal Portfolio Choice and the Capital Asset Pricing Model
12. Estimating the Cost of Capital
13. Investor Behavior and Capital Market Efficiency
PART 5: CAPITAL STRUCTURE
14. Capital Structure in a Perfect Market
15. Debt and Taxes
16. Financial Distress, Managerial Incentives, and Information
17. Payout Policy
PART 6: ADVANCED VALUATION
18. Capital Budgeting and Valuation with Leverage
19. Valuation and Financial Modeling: A Case Study
------
------
PART 1 INTRODUCTION
Chapter 1 Corporate Finance and the Financial Manager
Chapter 2 Introduction to Financial Statement Analysis
PART 2 INTEREST RATES AND VALUING CASH FLOWS
Chapter 3 Time Value of Money: An Introduction
Chapter 4 Time Value of Money: Valuing Cash Flow Streams
Chapter 5 Interest Rates
Chapter 6 Bonds
Chapter 7 Stock Valuation
PART 3 VALUATION AND THE FIRM
Chapter 8 Investment Decision Rules
Chapter 9 Fundamentals of Capital Budgeting
Chapter 10 Stock Valuation: A Second Look
PART 4 RISK AND RETURN
Chapter 11 Risk and Return in Capital Markets
Chapter 12 Systematic Risk and the Equity Risk Premium
Chapter 13 The Cost of Capital
PART 5 LONG-TERM FINANCING
Chapter 14 Raising Equity Capital
Chapter 15 Debt Financing
PART 6 CAPITAL STRUCTURE AND PAYOUT POLICY
Chapter 16 Capital Structure
Chapter 17 Payout Policy
PART 7 FINANCIAL PLANNING AND FORECASTING
Chapter 18 Financial Modeling and Pro Forma Analysis
Chapter 19 Working Capital Management
Chapter 20 Short-Term Financial Planning
PART 8 Special Topics
Chapter 21 Option Applications and Corporate Finance
Chapter 22 Mergers and Acquisitions
Chapter 23 International Corporate Finance  

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FINANCIAL MANAGEMENT AND CORPORATE FINANCE - COLLECTION 2017 (FREE DOWNLOAD)

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University
Free download - PPT - Link
Free donwload - PPT - Link


Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business
Free download - PPT - Link

International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick
Free download - PPT 1 - Link
Free download - PPT 2 - Link

Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University
Free download - PPT 1 - Link
Free download - PPT 2 - Link
Free download - PPT 3 - Link

Free download Link - Core 4

Excel Modeling in Corporate Finance, 5th Edition, 2015, Craig W. Holden, Indiana University
Fundamentals of Corporate Finance, 3rd Edition, 2015, Jonathan Berk, Stanford University, Peter DeMarzo, 
Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown

 

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017
Free download - PPT  - Link


Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016
Free download - PPT  - Link


Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University
Free download - PPT  - Link


Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown, 
Free download - PPT  - Link


Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin
Free download - PPT  - Link


Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter
 Free download - PPT  - Link

 

DOWNLOAD ALL TEST BANKs & CASE STUDY GUIDES - 2017

Corporate Finance, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo, Stanford University - Test bank

Financial Management: Concepts and Applications, 2015, Stephen Foerster, Richard Ivey School of Business - Test bank

Financial Management: Core Concepts, 3rd Edition, 2016, Raymond Brooks, Oregon State University - Test bank

International Financial Management, 2nd Edition, 2012, Geert J Bekaert, Columbia University, Robert J. Hodrick - Test bank

Financial Management: Principles and Applications, 12th Edition, 2015, Sheridan Titman, Arthur J. Keown - Test bank

Corporate Finance: The Core, 4th Edition, 2017, Jonathan Berk, Stanford University, Peter DeMarzo - Test bank

Fundamentals of Investing, 13th Edition, Scott B. Smart, Lawrence J. Gitman, Michael D. Joehnk, 2017 - Test bank

Multinational Business Finance, 14th Edition, David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett, 2016 - Test bank

Personal Finance, 6th Edition, 2017, Jeff Madura, Emeritus Professor of Finance; Florida Atlantic University - Test bank

Personal Finance: Turning Money into Wealth, 7th Edition, 2016, Arthur J. Keown - Test bank

Foundations of Finance, 9th Edition, 2017, Arthur J. Keown, John H. Martin - Test bank

Principles of Managerial Finance, 14th Edition, 2015, Lawrence J. Gitman, Chad J. Zutter - Test bank

 

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For Test Bankz, Quiz Answers and Case study Guides, email to: This email address is being protected from spambots. You need JavaScript enabled to view it.

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Good Luck and Success, Enjoy Your Study !

 

 

 

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