Saint MBA570 module 8 quiz

1.Monsters Incorporated (MI) is ready to launch a new product. Depending upon the success of this product, MI will have a value of either $100 million, $150 million, or $191 million, with each outcome being equally likely. The cash flows are unrelated to the state of the economy (i.e., risk from the project is diversifiable) so that the project has a beta of 0 and a cost of capital equal to the risk-free rate, which is currently 5%. Assume that the capital markets are perfect. The initial value of MI’s equity without leverage is closest to __________. (Points : 10) $133 million $147 million $140 million $150 millionQuestion 2.2.Which of the following statements is false? (Points : 10) The U.S. bankruptcy code was created to organize this process so that creditors are treated fairly and the value of the assets is not needlessly destroyed. Because the assets of the firm might be more valuable if kept together, creditors seizing assets in a piecemeal fashion might destroy much of the remaining value of the firm. Debt holders can then take legal action against the firm to collect payment by seizing the firm’s assets. The direct costs of bankruptcy are usually low because experienced professionals handle the process in an efficient manner.Question 3.3.Which of the following statements is false? (Points : 10) 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. 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. There is little incentive to increase debt levels so most firms should pay down debt to avoid potential bankruptcy. The probability of financial distress depends on the likelihood that a firm will be unable to meet its debt commitments and therefore default.Question 4.4.Which of the following statements is false? (Points : 10) When a firm faces financial distress, debt holders benefit from projects with a negative NPV. When a firm has leverage, a conflict of interest exists if investment decisions have different consequences for the value of equity and the value of debt. In some circumstances, managers may take actions that benefit shareholders but harm the firm’s creditors and lower the total value of the firm. Agency costs are costs that arise when there are conflicts of interest between stakeholders.Question 5.5.Which of the following statements is false? (Points : 10) One disadvantage of using leverage is that it does not allow the original owners of the firm to maintain their equity stake. The separation of ownership and control creates the possibility of management entrenchment; facing little threat of being fired and replaced, managers are free to run the firm in their own best interests. Managers also have their own personal interests, which may differ from those of both equity holders and debt holders. The costs of reduced effort and excessive spending on perks are another form of agency cost.Question 6.6.Which of the following statements is false? (Points : 10) Firms with high R&D costs and future growth opportunities typically maintain high debt levels. The tradeoff theory explains how firms should choose their capital structures to maximize value to current shareholders. With tangible assets, the financial distress costs of leverage are likely to be low, as the assets can be liquidated for close to their full value. Proponents of the management entrenchment theoryof capital structure believe that managers choose a capital structure to avoid the discipline of debt and maintain their own job security.Question 7.7.A firm can repurchase shares through a(n) __________ in which it offers to buy shares at a pre-specified price during a short time period-generally within 20 days. (Points : 10) tender offer open market share repurchases targeted repurchase Dutch auction share repurchaseQuestion 8.8.Which of the following statements is false? (Points : 10) When a firm pays a dividend, shareholders are taxed according to the dividend tax rate. If the firm repurchases shares instead, and shareholders sell shares to create a homemade dividend, the homemade dividend will be taxed according to the capital gains tax rate. When the tax rate on dividends exceeds the tax rate on capital gains, shareholders will pay lower taxes if a firm uses share repurchases for all payouts rather than dividends. Firms that use share repurchases will have to pay a higher pre-tax return to offer their investors the same after-tax return as firms that use dividends. The optimal dividend policy when the dividend tax rate exceeds the capital gain tax rate is to pay no dividends at all.Question 9.9.Which of the following statements is false? (Points : 10) Tax rates vary by income, by jurisdiction, and by whether the stock is held in a retirement account. Because of these differences, firms may attract different groups of investors depending on their dividend policy. While many investors have a tax preference for share repurchases rather than dividends, the strength of that preference depends on the difference between the dividend tax rate and the capital gains tax rate that they face. Long-term investors are more heavily taxed on capital gains, so they would prefer dividend payments to share repurchases. One-year investors, pension funds, and other non-taxed investors have no tax preference for share repurchases over dividends; they would prefer a payout policy that most closely matches their cash needs.Question 10.10.Which of the following statements is false? (Points : 10) Stocks generally trade in lots of 1,000 shares, and in any case do not trade in units less than one share. Non-cash special dividends are commonly used to spin off assets or a subsidiary as a separate company. The typical motivation for a stock split is to keep the share price in a range thought to be attractive to small investors. If a company declares a 10% stock dividend, each shareholder will receive one new share of stock for every 10 shares already owned.