Which one of the following statements concerning bankruptcy is correct?
A) A firm is considered bankrupt when it becomes delinquent on a loan payment.
B) The administrative expenses of a bankruptcy are classified as indirect bankruptcy costs.
C) Bankruptcy costs may offset the tax-related gains from leverage.
D) The higher cost of capital which a firm pays in order to avoid excessive debt is considered a direct cost of bankruptcy.
E) Bankruptcy is a relatively inexpensive process.

Question

Quizplus · Accepted Answer

Bankruptcy costs, including both direct costs (such as legal and administrative fees) and indirect costs (such as loss of customers, suppliers, or employees), can indeed offset the tax benefits that a firm might gain from using debt financing (leverage). This is because the potential for bankruptcy increases the firm's risk, which can lead to higher costs and reduced value.

Which One of the Following Statements Concerning Bankruptcy Is Correct