PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Chapter 18, Problem 12PS
a)
Summary Introduction
To discuss: Whether the statement is true or false.
b)
Summary Introduction
To discuss: Whether the statement is true or false.
c)
Summary Introduction
To discuss: Whether the statement is true or false.
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Suppose company Z is already in financial distress and the equity holders are very close to default. Suddenly there is a shock that causes an increase in the standard deviation of the return on company Z's assets. Which of the following correctly describes the new situation faced by company Z?
A) Debt value will increase with the shock and equity holder are more likely to default.
B) Equity value will increase with the shock and equity holder are less likely to default.
C) Both Debt value and equity value will increase but the likelihood of default is unchanged.
D) Both debt value and equity value will decrease and the likehood of default will increase.
What is meant by the term ‘financial distress’. If we assume that financial distress exists, explain how and why financial distress would cause a firm’s equity to become more risky.
If you are in financial hardship, explain what it means. If we suppose that financial hardship occurs, explain how and why financial distress would make a company's stock more hazardous.
Chapter 18 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 18 - Prob. 1PSCh. 18 - Tax shields Compute the present value of interest...Ch. 18 - Tax shields Here are book and market value balance...Ch. 18 - Tax shields Look back at the Johnson Johnson...Ch. 18 - Prob. 5PSCh. 18 - Tax shields The firm cant use interest tax shields...Ch. 18 - Prob. 7PSCh. 18 - Tax shields The trouble with MMs argument is that...Ch. 18 - Bankruptcy costs On February 29, 2019, when PDQ...Ch. 18 - Financial distress This question tests your...
Ch. 18 - Prob. 12PSCh. 18 - Agency costs Let us go back to Circular Files...Ch. 18 - Agency costs The Salad Oil Storage (SOS) Company...Ch. 18 - Agency costs The possible payoffs from Ms....Ch. 18 - Prob. 17PSCh. 18 - Prob. 18PSCh. 18 - Prob. 20PSCh. 18 - Pecking-order theory Fill in the blanks: According...Ch. 18 - Financial slack For what kinds of companies is...Ch. 18 - Financial slack True or false? a. Financial slack...Ch. 18 - Debt ratios Rajan and Zingales identified four...Ch. 18 - Leverage targets Some corporations debtequity...Ch. 18 - Prob. 26PSCh. 18 - Trade-off theory The trade-off theory relies on...
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- What are some of the risks an investor would face when investing in a stock? In addition to the business risk coming from the type of business environment that your company operates in, what additional risk would be of concern to an investor? The company might be mismanaged and do poorly or go out of business. The company's stock market return might be wildly unpredictable as the operating performance might be unstable. The company's competitors might do a better job and take market share away? The list goes on and on... What risks would you face if you bought 100 shares of Tesla?arrow_forwardThe use of financial leverage by the firm has a potential impact on which of the following? (1) The risk associated with the firm's operations. (2) The risk experienced by the stockholders (3) The variability of operating income (4) The variability of net income (5) The probability of going bankrupt Group of answer choices: 1, 2, 3 1, 3, 5 3, 4, 5 2, 3, 4 2, 4, 5arrow_forward7. When faced with financial distress, managers of firms acting on behalf of their shareholders' interests will tend to: I) Favour high-risk, high-return projects even if they have negative NPV; II) Refuse to invest in low-risk, low-return projects with positive NPVs; III) Delay the onset of bankruptcy as long as they can II only I, II, and III III only I onlyarrow_forward
- Liquidity risk is A) the risk of bad business strategy or management decisions being madeB) the risk that a company will be unable to meet its financial obligationsC) the risk of not being able to close out your position quickly and at a fair priceD) the risk of prices going up or downE) also known as inflation riskarrow_forward1.Financial distress is least apt to lead to A. Increase dividends B.financial restructuring C.Liquidation D.Issuing new shares E.Asset restructuring 2.Which following is false regarding with free cash flows? A. If FCFF are positive then FCFE will be positive. B.If FCFF are negative then firms will need to borrow money to reduce net profits to shareholders to maintain investment needs C. If FCFE are positive then FCFF may also be positive D. If FCFE are negative then FCFF maybe positive E. None of the options provided.arrow_forwardWhich of the following statements is FALSE? As debt increases, the risk associated with bankruptcy and agency costs is reduced. Debt is often the least costly form of financing for a firm. Firms should probably use some debt in their capital structure. Different firms are subject to different levels of risk.arrow_forward
- Describe clearly how theories from behavioural finance can justify the following abnormal phenomena of investment: (1) Investors exhibit tendency to overpay for assets with poor average return but a potential to deliver a huge payoff, such as penny stocks or corporate bonds of financially distressed companies. (2) Investors exhibit tendency to sell winning stocks too early but hold losing stocks for too longarrow_forwardIf the stock market is efficient, why do companies manage their earnings? O To avoid violating debt covenants. O To receive bonuses based on reported earnings. O Because companies do not believe the Efficient Market Hypothesis. O All of the above.arrow_forward3. Compare and contrast operating leverage vs. financial leverage.4. What are the factors that will affect break-even and explain a circumstance of how it would affect your decision-making?5. Discuss a warning sign that could result in bankruptcy (either personal or for a business), and what you would do to fix the problem?arrow_forward
- A Moving to another question will save this response. Question 6 According to the risk shifting (or asset substitution) hypothesis Shareholders are keen to take excessively risky projects as they do not internalize the negative externality to bondholders O Firms should never pay dividends O Companies become too conservative in their investment when debt levels are such that bankruptcy is a likely outcome O It is always optimal to reduce leverage as this reduces expected bankruptcy costs A Moving to another question will save this response. ipeg WhatsApp Image..jpeg WhatsApp Image.jpeg WhatsApp Image...jpeg WhatsApp Image..jpeg WhatsApp Im. Shot on vivo Z1x 00 16°C Mostly cloudy WIDE Vivo Al cameraarrow_forwardIf the market value of a firm becomes less than its book value, it becomes an attractive takeover target.the firm will be delisted by the stock exchange.the Securities and Exchange Commission will not allow it to declare dividends until the market value once again exceeds the book value.the firm will be unable to service its debt.arrow_forwardWhich of the following statements is false? Group of answer choices a.If management does not consider the needs of the bondholders of a firm, they could end up destroying shareholder value b.If management chooses to ignore the needs of bondholders when structuring a firm, the firm can be expected to have to pay a higher interest rate on its debt c.In a perfect capital market, if a firmʹs current capital structure is not optimal, one can expect that firm to be a takeover target d.Management should focus only on the needs of a firmʹs shareholders since they are the true owners of the firm and, as such, they elect the firmʹs directorsarrow_forward
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