Deck 16: Bankruptcy Costs and Debt Holder-Equity Holder Conflicts

Question 1

Which of the following factors can minimize the incentive costs associated with debt financing?

A)Issuing marketable securities
B)Ownership transfers
C)Protective covenants
D)Publicly placed debt

Answer 1

C

Question 2

The debt overhang problem explains that:

A)in an attempt to take advantage of tax shields,firms excessively issue debt increasing the risk of bankruptcy.
B)the threat of bankruptcy does not affect a firm's relationships with its lenders.
C)firms may pass up profitable investments if equity holders under invest.
D)equity holders have a tendency to take on overly risky projects,even when they have a negative NPV.

Answer 2

C

Question 3

When a parent firm is not responsible for the project's debt the project is said to be financed with a _____.

A)subordinated debt
B)senior debt
C)non-recourse debt
D)junior debt

Answer 3

C

Question 4

Explain the debt overhang problem.

Question 5

Explain the cash flows related to bankruptcy.

Question 6

What are liquidation costs and bankruptcy costs?

Question 7

Impaired creditors refer to:

A)the creditors who have claims on the impaired assets.
B)the guarantors who act as an intermediary between the creditors and the bond issuers.
C)the creditors who has been given priority in payments in the event of a bankruptcy.
D)the creditors who will not be paid in full.

Question 8

Which of the following is true of the direct costs of bankruptcy?

A)Direct costs of bankruptcy do not include legal costs.
B)Most of the direct costs of bankruptcy are the same for both small and large firms.
C)Direct costs of bankruptcy for small firms,as a proportion of the value of their assets,are much smaller than those for large firms.
D)Most direct bankruptcy costs are only borne by the firm's equity holders.

Question 9

The US equivalent to administration is:

A)filing for Chapter 11 bankruptcy.
B)filing for Chapter 7 bankruptcy.
C)'Regulation on Insolvency Proceedings'.
D)Insolvency Law of 2003.

Question 10

The ability to issue debt that is senior to existing debt _____.

A)eliminates the debt overhang problem
B)decreases the asset substitution problem
C)increases the credit rating of the firm
D)can reduce the NPV of new projects

Question 11

The default premium reflects the:

A)ratio of the total risk premium of a bond to the total costs of bankruptcy of the issuing firm.
B)probability and cost of the firm's bankruptcy.
C)ratio of the total risk premium of a bond to the yield on a bond with no default.
D)additional return on a bond for liquidity shortcomings.

Question 12

Explain the liquidation process.

Question 13

Which of the following is a reason why conflicts are lower among the capital providers of firms financed with short-term debt?

A)Short-term debt is not affected by credit ratings of other outstanding long-term debt.
B)Short-term debt cannot be repaid by issuing other long-term debt.
C)Firm value is not affected by short-term debt and only takes into account long-term debt and equity.
D)Short-term debt is less sensitive to a firm's investment decisions.

Question 14

Which of the following is true of the asset substitution problem?

A)Debt provides an incentive for firms to take on unnecessary risk,substituting riskier investment projects for less risky projects.
B)Equity holders may want to keep a firm operating when its liquidation value exceeds its operating value.
C)Equity provides an incentive for firms to take on unnecessary risk investing in projects with a negative NPV.
D)Equity holders have a tendency to take on only riskless projects,even when they have negative NPV.

Question 15

Which of the following defines the term "wound up"?

A)It is the process in which a firm in the UK that is unable to make the required payments to their creditors can be voluntarily or compulsorily dissolved.
B)It is the refers to the UK government's disinvestment policy that allows firms to be liquidated and sold to the UK government.
C)It is a process that allows a firm in the UK facing cash flow problems and financial distress,to reduce and renegotiate its delinquent debts in order to avoid liquidation.
D)It is the process in which a firm in the UK refinances a debt in default by further borrowings to avoid bankruptcy.

Question 16

The reluctance to liquidate problem explains that:

A)if a firm is on the verge of liquidation,equity holders have a tendency to take on overly risky projects,even when they have negative NPV.
B)equity holders may want to keep a firm operating when its liquidation value exceeds its operating value.
C)equity holders have a tendency to take on overly risky projects,even when they have negative NPV.
D)debt holders may want to keep a firm operating when its liquidation value exceeds its going concern value.

Question 17

Which of the following is the main objective of an administrator in the context of bankruptcy?

A)To act as a financial intermediary who administrate the daily banking transactions
B)To audit and prepare the financial statements during the bankruptcy period
C)To certify that the periodic report containing the financial statements are transparent
D)To restructure debt and equity claims and restore the company as a going concern

Question 18

Direct bankruptcy costs:

A)will have no impact on the cash flows of the firm.
B)arise because financial distress in the economy and affect all firms.
C)relate to the legal process involved in reorganizing a bankrupt firm.
D)arise among financially distressed firms,or those firms that are close to bankruptcy.

Question 19

Liquidation costs are the:

A)the sum of the financing and investing costs minus the liquidation value of the firm.
B)sum of the present value of the future cash flows that the firm's assets would generate if it were to continue operating and a liquidation premium.
C)sum of the present value of the future cash flows that the firm's assets would generate if it were to continue operating and its liquidation value.
D)difference between a firm's going concern value and its liquidation value.