CF Chapter 16 Flashcards
Does the risk of bankruptcy follow as a disadvantage?
No, as a debt bankruptcy means a shift from equity holder to debt holders
What is the U.S bankruptcy code?
The process of organizing that the seizing of assets does not destroy value
What is liquidation?
The firms assets are sold through a auction and this is to pay a firms creditors
What is reorganization?
All pending collections are suspended and the firms management get a opportunity to propose a reorganization plan
What are direct costs of bankruptcy?
The direct costs reduce the value of the assets that the firms investors will receive
What is a workout? (Bankruptcy)
When a firm is succesful at reorganization outside of bankruptcy
What is a prepackaged bankruptcy?
A firm will first develop a reorganization plan with agreement of creditors and then file for chapter 11
What are the types of indirect costs of financial distress?
- Loss ofcustomers
- Loss of suppliers
- Loss of employees
- Loss of receivables
- Fire sale of assets
- Inefficient liquidation
- Costs to creditors
Debt holders will reduce the value of a firm in case of financial distress costs, what is the formula ultimately of the value of a levered firm?
VL = VU + PV (interest tax shield) - PV (financial distress costsWhat are t
What are the three key factors in determining the present value of financial distress costs?
- The probability of financial distress
- The magnitude of the costs if the firm is in distress
- The appropriate discount rate for the distress costs
What are agency costs?
The costs that arise when there is a conflict of interest between stakeholders
What is the idea of excessive risk taking in financial distress?
Well when a firm faces financial distress. the shareholder can gain from decisions that increa the risk of the firm sufficiently, even if they have a negative NPV
What is revered to as the asset substitution problem?
That leverage gives shareholders an incentive to replaye low-risk assets with riskier ones
What is the idea of debt overhang / Under-investment problem?
When shareholders prefer not to invest in positive-NPV projects in financial distress
What is cashing out?
If a firm faces financial distress, shareholders may have an incentive to withdraw cash from the firm
What is the leverage hatchet effect?
Once existing debt is in place, shareholders have an incentive to increase leverage even if it decreases the value of the firm and shareholders will not have an incentive to decrease leverage by buying back debt, even if it will increase the value of the firm
What happens with the agency costs of short-term debt?
IT becomes smaller due to less opportunities to profit at the expense of debt holders
What are debt covenants?
Restrictions placed on action that a firm can take and this reduces agency costs
What is management entrenchment?
With facing little threat of being fires, managers are free to run the firm in their own best interest
What is empire building?
When a manager is willing to engage in negative-npv investments as managers prefer to lead large firms
What is overconfidence in agency costs?
When managers act in shareholders interest, but make mistakes due to believe
What does leverage and agressive strategies have to do?
A highly leveraged firm may become a fierce competitor to protect its markets as it cannot risk bankruptcy
