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Saint MBA570 module 8 quiz (August 23, 2014)




Question;Question 1.1.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 creditors must vote to accept the Chapter 11 reorganization plan, and the bankruptcy court must approve it. If an acceptable plan is not put forth, the court may ultimately force a Chapter 7 liquidation of the firm.The U.S. bankruptcy code was created to protect the rights of managers and shareholders.When a corporation becomes financially distressed, outside professionals, such as legal and accounting experts, consultants, appraisers, auctioneers, and others with experience selling distressed assets, are generally hired.In the case of Chapter 11 reorganization, creditors must often wait several years for a reorganization plan to be approved and to receive payment.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.A type of agency problem that results in shareholders gaining from decisions that increase the risk of the firm sufficiently, even if they have negative NPV is: (Points: 10) asset substitution.debt overhang.underinvestment.cashing out.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.The idea that 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 is known as the: (Points: 10) pecking order hypothesis.credibility principle.lemons principle.signaling theory of debt.Question 7.7.Which of the following statements is false? (Points: 10) From an accounting perspective, dividends generally reduce the firm?s current (or accumulated) retained earnings.The way a firm chooses between paying dividends, repurchasing shares and retaining earnings is referred to as its payout policy.Most companies that pay dividends pay them semiannually.Occasionally, a firm may pay a one-time, special dividend that is usually much larger than a regular dividend.Question 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.


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