36) The complete termination of a firm as a going business concern is called a
A) merger.
B) repurchase program.
C) liquidation.
D) divestiture.
E) reorganization.
37) A firm that has a negative net worth is said to be
A) experiencing accounting insolvency.
B) in legal bankruptcy.
C) experiencing technical insolvency.
D) experiencing a business failure.
E) in Chapter 11 bankruptcy reorganization.
38) A legal attempt to financially restructure a failing firm so that it can continue operating as a
going concern is called a
A) merger.
B) reorganization.
C) liquidation.
D) repurchase program.
E) divestiture.
39) A firm is technically insolvent when
A) the value of its stock declines by more than 50 percent in any given 12-month period.
B) the value of the firm’s assets is less than the value of the firm’s liabilities.
C) it files the legal forms petitioning for bankruptcy protection.
D) it is unable to meet its financial obligations.
E) it has a negative net worth on its balance sheet.
40) Which one of the following statements is correct concerning a Chapter 7 bankruptcy?
A) A firm reorganizes its operations in an effort to return to being a viable concern.
B) A trustee will assume control of the firm’s assets until those assets can be liquidated.
C) Chapter 7 bankruptcies are always involuntary on the part of the firm.
D) The claims of creditors are paid prior to the bankruptcy administrative costs.
E) The firm generally issues new shares of stock prior to coming out of bankruptcy.
41) Which one of the following claims on a firm would be paid first in a bankruptcy liquidation if
the court adheres to the absolute priority rule?
A) Government tax claims
B) Wages, salaries, and commissions
C) Consumer claims
D) Preferred stockholder dividends
E) Contributions to employee benefit plans
42) Which one of these describes a bankruptcy situation known as a “cram down”?
A) The absolute priority rule forces common shareholder claims to the very bottom of the payee
list.
B) Creditors are forced to accept a bankruptcy plan that they voted to reject.
C) The filing firm can be forced by the court to accept a plan submitted by the firm’s creditors.
D) Shareholders are forced to forfeit all of their claims on the bankrupt firm.
E) A firm submits a reorganization plan simultaneously with its bankruptcy petition thereby
forcing the court to agree to the submitted plan.
43) A firm may file for Chapter 11 bankruptcy
I. in an attempt to gain a competitive advantage.
II. using a prepack.
III. while allowing the current management to continue running the firm.
IV. even though it is not insolvent.
A) I and III only
B) I, II, and IV only
C) I and II only
D) III and IV only
E) I, II, III, and IV
44) As an attempt to avoid bankruptcy, a firm may
A) agree to a composition with its creditors.
B) employ the stalking horse strategy.
C) develop a prepack agreement.
D) take advantage of a Section 363 auction.
E) ask a trustee to enact the absolute priority rule.
45) Bart’s Mart will have a value of $59,000 if the economy does well this next year and a value of
$52,000 if the economy does poorly. The probability of a good economy is 72 percent. The firm
owes its bondholders $12,000. What is the market value of the firm if it only operates for one more
year?
A) $57,680
B) $54,650
C) $57,040
D) $56,560
E) $55,850
46) The Window Store will have a value of $139,000 if the economy does well this coming year
and a value of $121,000 if the economy does poorly. The probability of a good economy is 68
percent. The firm owes its bondholders $63,000. The firm will only operate for one more year.
What is the value of this firm to its shareholders?
A) $68,500
B) $70,240
C) $70,450
D) $73,550
E) $74,660
47) For next year, the probability the economy will do well is 82 percent, and Importers Unlimited
will have a firm value of $68,000. If the economy tanks, the firm’s value will decline to $43,000.
The firm owes its bondholders $50,000. What is the value of this firm to its shareholders if the firm
will close after next year?
A) $14,760
B) $13,380
C) $18,000
D) $16,410
E) $13,520
48) ATC has a value of $98,000 in a normal economy and $87,000 in a recession. The firm has
$90,000 of debt. The probability of a recession is 18 percent. The firm is considering a project that
would change the firm values to $105,000 in a good economy and $92,000 in a recession. If the
firm accepts this project, the firm value will ________ and shareholder value will ________.
A) decrease by $2,000; decrease by $1,000
B) increase by $2,000; increase by $2,000
C) increase by $6,640; increase by $6,100
D) increase by $12,000; increase by $12,000
E) increase by $6,640; increase by $6,640
49) Burger Queen has a value of $38,000 in a good economy and $24,000 in a recession. The firm
has $25,000 of debt. The probability of a recession is 50 percent. The firm is considering a project
that would change the firm values to $42,000 in a good economy and $22,000 in a recession. Will
shareholders accept this project? Will bondholders like this project?
A) Both shareholders and bondholders will like this project.
B) Neither shareholders nor bondholders will like this project.
C) Shareholders, but not bondholders, will like this project.
D) Bondholders, but not shareholders, will like this project.
E) Shareholders will like this project but bondholders will be indifferent.
50) Dairy Isle has a value of $59,000 in a good economy and $48,000 in a recession. The firm has
$50,000 of debt. The probability of a recession is 32 percent. The firm is considering a project that
would change the firm values to $63,000 in a good economy and $46,000 in a recession. Which
one of these statements correctly describes the effects of this project?
A) The bondholders and stockholders equally share the increase in firm valuation.
B) The bondholders are unaffected by the project.
C) The shareholders gain an amount equal to 68 percent of the increase in the firm’s value.
D) The shareholders gain $2,080 while the bondholders are unaffected.
E) The project transfers $640 from bondholders to stockholders.
51) Miller Tool plans on closing its doors after one more year. During its last year in business, the
firm expects to generate a cash flow of $76,000 if the economy booms and $58,000 if it does not.
The probability of a boom is 15 percent. The firm has debt of $62,500 that is due in 1 year. That
debt has a market value of $58,300 today. Ignore taxes. The current promised return on debt is
________ percent, and the expected return on debt is ________ percent.
A) 7.20; 8.13
B) 8.18; 1.03
C) 8.18; 9.12
D) 7.20; 0.64
E) 8.36; 1.98
52) The Sawmill expects to generate a cash flow of $59,000 next year if the economy booms and
$46,000 if it does not. The probability of a boom is 20 percent. The firm has debt of $52,000 that is
due in 1 year and has a current market value of $48,700. The firm plans to close after this coming
year. The current promised pretax return on debt is ________ percent, and the expected pretax
return on debt is ________ percent.
A) 6.78; 1.16
B) 6.78; –3.08
C) 5.49; 1.16
D) 5.49; –2.67
E) 6.27; –3.08
53) Custer’s has bonds outstanding with a face value of $98,000 that are selling at par. It also has
12,000 shares of stock outstanding that are selling for $25.90 a share. The all-equity value of the
firm is $398,000. The tax rate is 35 percent. By what amount has the value of the firm been
decreased by the expected bankruptcy costs? Assume there are no other claims on the firm.
A) $21,300
B) $18,900
C) $23,500
D) $0
E) $20,750
54) Cool Refreshments has bonds outstanding with a face value of $211,000 that are selling at par.
It also has 14,000 shares of stock outstanding that are selling for $16.20 a share. The all-equity
value of the firm is $408,000. The tax rate is 35 percent. What is the value of the financial distress
costs? Assume there are no other claims on the firm.
A) $44,050
B) $46,800
C) $46,220
D) $45,100
E) $46,550
55) Kat owns and manages a small all-equity firm. If she works 40 hours a week, the firm’s annual
EBIT will be $38,000. If she increases her hours to 45 a week, EBIT will increase to $43,000. The
firm has a current value of $210,000. Kat wants to expand the business and needs $76,000 to do so.
The firm can borrow the needed funds at an interest rate of 6.7 percent, or it can issue equity.
Ignore taxes. Kat will prefer
A) debt with a 40-hour week as that option provides her with the highest cash flow.
B) debt with a 45-hour week as her cash flow will be $5,000 greater than her next best option.
C) equity with a 45-hour week as her cash flow will be $5,006 higher than a 45-hour week with
debt.
D) equity with a 40-hour week as that option provides her with the highest cash flow.
E) debt with a 45-hour week as her cash flow will be $31,573.
56) Marcus owns and manages OLK, which is an all-equity firm. If he works 40 hours a week, the
firm’s annual EBIT will be $96,000. If he increases his hours to 45 a week, EBIT will increase to
$108,000. The firm has a current value of $926,000. Marcus needs $250,000 to fund a new project.
The firm can borrow the needed funds at an interest rate of 6 percent, or it can issue equity. Ignore
taxes. Marcus will prefer
A) debt with a 40-hour week as that option provides him with the highest cash flow.
B) debt with a 45-hour week as his cash flow will be $11,000 greater than his next best option.
C) equity with a 45-hour week as his cash flow will be $85,041.
D) equity with a 40-hour week as that option provides him with the lowest cash flow.
E) debt with a 45-hour week as his cash flow will be $7,959 higher than if he works 45 hours and
shares his equity.