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Chapter 16 - Chapter16-FinancialDistress,,andInformation...

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Chapter 16  -  Financial Distress, Managerial Incentives, and Information 16.1 Default and Bankruptcy in a Perfect Market  1) 
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Which of  the following statements is false?  A) 
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Equity holders  expect to receive dividends and the firm is legally obligated to pay them.  B) 
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A firm that fails  to make the required interest or principal payments on the debt is in default.  C) 
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In the extreme  case, the debt holders take legal ownership of the firm's assets through a process called bankruptcy.  D) 
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After a firm  defaults, debt holders are given certain rights to the assets of the firm.  Answer:  
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Explanation:  
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A) 
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D) 
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Diff: 1  Topic: 16.1 Default and Bankruptcy in a Perfect Market  Skill: Conceptual    2) 
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Which of  the following statements is false?  A) 
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An important  consequence of leverage is the risk of bankruptcy.  B) 
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Whether default  occurs depends on the cash flows, not on the relative values of the firm's assets and liabilities.  C) 
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Economic  distress is a  significant decline in the value of a firm's assets, whether or not it experiences financial distress due to leverage.  D) 
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Modigliani and  Miller's results continue to hold in a perfect market even when debt is risky and the firm may default.  Answer:  
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Explanation:  
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A) 
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D) 
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Diff: 2  Topic: 16.1 Default and Bankruptcy in a Perfect Market  Skill: Conceptual   
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Use the information for the question(s) below. Monsters Incorporated (MI) in 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.   3) 
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