Corporate Finance Exam

What does risk-neutrality mean?

Investors are indifferent to the presence of risk

Can one have bankruptcy risk without bankruptcy costs?

Yes. When a firm takes on debt, the risk of bankruptcy is always present but bankruptcy cost may not be

Why do we say that stockholders bear bankruptcy costs?

Because in the presence of bankruptcy costs, bondholders would pay less for any debt issued. This then will reduce the value of potential future dividends

What is the main direct cost of financial distress?

Legal and administrative costs of liquidation or reorganization

What are the indirect costs of financial distress?

Those that arise because of an impaired ability to conduct business - such as loss of reputation, loss of customers, low employee morale, etc.

Who pays the costs of selfish strategies?

Ultimately, the stockholders

How can covenants and debt consolidation reduce debt agency costs?

Covenants can increase the value of the firm which is favoured by shareholders as well as protecting bondholders. They offer the lowest-cost solution to the shareholder-bondholder conflict.

List all the claims to the firm’s assets

Payments to stockholders and bondholders, payments to the government, payments to lawyers, and payments to any and all other claimants to the cash flows of the firm.

Describe marketed claims and nonmarketed claims

* Marketed claims are claims that can be sold or bought in capital markets
* Nonmarketed claims are claims that cannot be sold in capital markets

How can a firm maximize the value of its marketed claims?

By minimizing the value of nonmarketed claims such as taxes