1. In financial distress, firms may make sub-optimal investment decisions. Explain the rationale behind this statement.
2. What are the direct and indirect costs of bankruptcy? Give examples of firms with high and low bankruptcy costs and explain.
3. Stockholders need not be concerned with bankruptcy costs since they will be borne by bondholders. Comment. (Assume that the firm declares bankruptcy when the value of assets is less than the value of obligations to bondholders. Thus, in bankruptcy, equity has zero value.)
4. Stock prices fall when firms issue new shares because of the dilution of existing shareholders position. Comment.
5. "A firm should not pay a dividend if it can reinvest the money in new projects at a profitable rate. Otherwise, shareholders will lose the value of the foregone projects." Comment.