One of the indirect costs of bankruptcy is the incentive toward underinvestment.Underinvestment generally would result in:
A)the firm selecting all projects with positive NPVs.
B)the firm turning down positive NPV projects that would clearly be accepted if the firm were all-equity financed.
C)bondholders contributing the full amount of any new investment,but both stockholders and bondholders sharing in the benefits of those investments.
D)shareholders making decisions based on the best interests of the bondholders.
E)the firm accepting more projects than it would if the probability of bankruptcy was ignored.

Question

Quizplus · Accepted Answer

When a firm is under financial distress, it may be forced to prioritize debt repayment over investments, leading to underinvestment. In this situation, the firm may turn down positive NPV projects that would have been accepted if the firm was not in financial distress. This is because the firm may want to conserve its cash flow and avoid defaulting on its debts. Therefore, underinvestment results in the rejection of positive NPV projects.

One of the Indirect Costs of Bankruptcy Is the Incentive