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, which include legal fees and other expenses associated with the process, may offset the tax-related gains from leverage. This means that even if a firm is able to deduct interest payments on their debt for tax purposes, the costs of bankruptcy may outweigh these benefits. Option A is incorrect because becoming delinquent on a loan payment does not automatically mean a firm is considered bankrupt. Option B is incorrect because administrative expenses are considered direct bankruptcy costs. Option D is incorrect because the higher cost of capital to avoid excessive debt is considered an indirect cost of bankruptcy. Option E is incorrect because bankruptcy can be a very expensive process.

Which One of the Following Statements Concerning Bankruptcy Is Correct