1) Two key qualitative factors determine ________ of financial distress costs: (1) the probability of financial distress and (2) the magnitude of the costs after a firm is in distress.

A) the market value

B) the book value

C) the future value

D) the present value

2) Which of the following statements is false?

A) Real estate firms are likely to have low costs of financial distress, as much of their value derives from assets that can be sold relatively easily.

B) For low levels of debt, the risk of default remains low and the main effect of an increase in leverage is an increase in the interest tax shield, which has present value *D, where * is the effective tax advantage of debt.

C) Firms whose value and cash flows are very volatile (for example, semiconductor firms) must have much higher levels of debt to avoid a significant risk of default.

D) The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.

Answer: Explanation:

3) Which of the following industries is likely to have the lowest costs of financial distress?

A) Airline

B) Computer Software

C) Biotechnology

D) Electric Utilities

4) Which of the following industries likely to have the highest costs of financial distress?

A) Grocery store

B) Semiconductors

C) Real estate

D) Utilities

Use the information for the question(s) below.

Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding. Suppose that Big Blue Banana announces plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.

6) Assuming perfect capital markets, the share price for BBB after this announcement is closest to:

A) $11.40

B) $10.85

C) $10.00

D) $8.60

Answer:

Explanation:

7) Suppose that BBB pays corporate taxes of 35% and that shareholders expect the change in debt to be permanent. Assuming that capital markets are perfect except for the existence of corporate taxes, the share price for BBB after this announcement is closest to:

A) $10.00

B) $10.85

C) $8.60

D) $11.40

Answer: Explanation:

8) Suppose that BBB pays corporate taxes of 35% and that shareholders expect the change in debt to be permanent. Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs. If the price of BBB's stock rises to $10.85 per share following the announcement, then the present value of BBB's financial distress costs is closest to:

A) $21.25 million

B) $35.00 million

C) $11.40 million

D) $13.75 million

Answer: Explanation: