lecture chapter 16

Question 1

financial distress

Answer 1

When a firm has difficulty meeting its debt obligation

Question 2

default

Answer 2

when a firm fails to make the required interest or principal payments on its debt

After a firm defaults, debt holders are given certain rights to the assets of the firm and may even take legal ownership of the firms assets through bankruptcy

Question 3

two ways to deal with bankruptcy

Answer 3

Liquidation
Reorganization

Question 4

Liquidation

Answer 4

All company assets are sold

The proceeds from the liquidation are used to pay the firms creditors, and the firm ceases to exist

Question 5

Reorganization

Answer 5

It is the more common form of bankruptcy for large corporations

The firms existing management is given the opportunity to propose a reorganization plan

While developing the plan, management continues to operate the business

Question 6

Optimal capital structure (trade off theory)

Answer 6

The total value of a levered firm equals the value of the firm without leverage plus the present value of the tax savings from debt, less the present value of financial distress costs