Corporate Finance

Front 1

The higher the firm’s beta, is it more or less likely the firm will be in distress?

Back 1

More likely

Front 2

What alternative to bankruptcy method happens when companies negotiate directly with creditors and work out an agreement?

Back 2

Workout

Front 3

What alternative to bankruptcy is when the company first creates a reorganization plan with the agreement of its primary creditors, and then file chapter 11 reorganization to implement the plan?

Back 3

Prepackaged bankeuptcy

Front 4

Balancing the value-enhancing effects of debt on a firm’s capital structure with the value reducing effects is called what?

Back 4

Trade-off Theory

Front 5

What is the formula for the value of a firm, VL with respect to trade off theory

Back 5

VL= Vu + PV(interest tax shield) + PV(agency benefits of debt) - PV(financial distress costs) - PV(Agency costs of debt)

Front 6

Where does the optimal level of debt, D* occur?

Back 6

At the point where the firm’s value is maximized

Front 7

Firms with high research and development costs typically maintain (high or low) levels of debt?

Back 7

Low levels of debt

Front 8

Mature, low-growth firms with stable cash flows and tangible assets benefit from (high or low debt)

Back 8

High debt

Front 9

What is the term for when managers prefer to make financing decisions that send positive rather than negative signals to outside investors

Back 9

Pecking order Hypothesis

Front 10

The pecking order (from most favored to least favored financing option)

Back 10

Retained earnings (internal equity)

Debt

Equity (external equity)

Front 11

Adverse selection has the following 3 implications for equity issuance

Back 11

The stock price tends to rise prior to the announcement of an equity issue

The stock price declines on the announcement of an equity issue

Firms tend to issue equity when information asymmetries are minimized, such as immediately after earnings announcement

Front 12

Issuing equity is typically viewed as a positive or negative signal?

Back 12

Negative signal

Front 13

Issuing more debt is typically viewed as a positive or negative signal?

Back 13

Positive signal

Front 14

Claims in one’s self interest are credible only if they are supported by actions that would be too costly to take if the claims were untrue

Back 14

Credibility principle

Front 15

A seller with private information is likely to sell you worse than average goods

Back 15

Adverse selection

Front 16

When managers have private information about the value of a firm, investors will discount the price they are willing to pay for new equity issue due to adverse selection

Back 16

Lemon’s Principle

Front 17

What is it called when managers have more information about a firm than investors?

Back 17

Asymmetric information

Front 18

What are 3 costs of asymmetric information?

Back 18

Lemon’s Principle

Adverse Selection

Credibility Principle

Front 19

Wasteful spending is more likely to happen when firms have high levels of cash flow in excess of what is needed is called what?

Back 19

Free cash flow hypothesis

Front 20

How can leverage provide incentive for managers to run a firm more efficiently and effectively due to what?

Back 20

Increased ownership concentration

Reduced wasteful investment

Reduced managerial entrenchment and increased committment

Front 21

What are 3 agency benefits of leverage?

Back 21

Empire Building

Managerial Entrenchment

Free cash flow hypothesis

Front 22

What is it called when managers tend to take on investments that increase the size, rather than the profitability, of the firm

Back 22

Empire Building

Front 23

Because managers face little threat of being replaced, managers can run the firm to suit their interests?

Back 23

Managerial Entrenchment

Front 24

After the firm defaults, the debt holders have claims to the firm’s assets through a legal process called what?

Back 24

Bankruptcy

Front 25

How can firms and debt holders mitigate the agency costs of debt

Back 25

Issue short term debt

Include debt covenant in bonds that place restrictions on the actions a firm can take

Front 26

What are 3 agency costs of leverage

Back 26

Excessive risk taking and asset substitution

Debt overhang or underinvestment

Cashing out

Front 27

What is it called when a company replaces its low risk assets with high risk investments? Shareholder may benefit from high risk projects, even those with negative NPV

Back 27

Excessive risk taking and asset substituition

Front 28

Shareholders may be unwilling to finance new, positive NPV projects

Back 28

Debt overhang or underinvestment

Front 29

Who bears most directly the financial distress costs?

Back 29

Equity holders

Front 30

Who bears the agency costs when an unlevered firm issues new debt?

Back 30

Equity holders

Front 31

Once a firm has debt already in place and some of the bankruptcy or agency costs from taking on additional debt can fall on

Back 31

Existing debt holders

Front 32

What are the 3 components for the present value of financial distress costs

Back 32

The costs of financial distress and bankruptcy, in the event they occur

The probability of financial distress and bankruptcy occurring

The appropriate discount rate for the distress costs

Front 33

What are the fees to outside professionals like legal and accounting experts, consultants, appraisers, auctioneers, and investment bankers called?

Back 33

Direct costs

Front 34

The direct costs of financial distress are typically higher or lower for firms with more complicated business operations

Back 34

Higher

Front 35

The direct costs of financial distress are typically higher or lower, in percentage terms, for smaller firms

Back 35

Higher

Front 36

The loss of customers, suppliers, employees, receivables, fire sale of assets, inefficient liquidation, and costs to creditors are examples of what type of costs?

Back 36

Indirect costs

Front 37

Are indirect costs more or less difficult to measure than direct costs

Back 37

More difficult

Front 38

Are indirect costs larger or smaller than direct costs?

Back 38

Larger

Front 39

True or False: indirect costs may occur even prior to bankruptcy if the potential perceived threat of future bankruptcy is high

Back 39

True

Front 40

Companies with marketable tangible assets (e.g., airlines, steel manufacturer’s) have higher or lower financial distress than companies without these assets because tangible assets can be sold relatively easily

Back 40

Lower

Front 41

Do companies with a higher debt to equity ratio have a higher or lower probability of bankruptcy

Back 41

Higher

Front 42

Does the probability of bankruptcy increase or decrease when the volatility of the firm’s cash flows and asset values increases?

Back 42

Increase

Front 43

Firms with what kind of cash flows can use high levels of debt and still have low probability of default?

Back 43

Steady cash flows

Front 44

Firms with what kind of cash flows must have low levels of debt in order to have low probability of default?

Back 44

Volatile cash flows

Front 45

Who most directly bears the financial distress costs?

Back 45

Equity holders

Front 46

What is a security whose cash flows are backed by the cash flows of its underlying assets?

Back 46

Asset backed security (ABS)

Front 47

What is the biggest sector the ABS market?

Back 47

Mortgage backed security (MBS)

Front 48

What is the biggest sector the ABS market?

Back 48

Mortgage backed security (MBS)

Front 49

An MBS has its cash flows backed by what?

Back 49

Home mortgages

Front 50

What kind of risk do the holders of an MBS face because mortgages can be repaid early?

Back 50

Prepayment Risk