公司金融课后题答案CHAPTER 17.docx

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公司金融课后题答案CHAPTER 17

CHAPTER 17CAPITAL STRUCTURE: LIMITS TO THE USE OF DEBTAnswers to Concepts Review and Critical Thinking Questions1.Direct costs are potential legal and administrative costs. These are the costs associated with the litigation arising from a liquidation or bankruptcy. These costs include lawyer’s fees, courtroom costs, and expert witness fees. Indirect costs include the following: 1) Impaired ability to conduct business. Firms may suffer a loss of sales due to a decrease in consumer confidence and loss of reliable supplies due to a lack of confidence by suppliers. 2) Incentive to take large risks. When faced with projects of different risk levels, managers acting in the stockholders’ interest have an incentive to undertake high-risk projects. Imagine a firm with only one project, which pays $100 in an expansion and $60 in a recession. If debt payments are $60, the stockholders receive $40 (= $100 – 60) in the expansion but nothing in the recession. The bondholders receive $60 for certain. Now, alternatively imagine that the project pays $110 in an expansion but $50 in a recession. Here, the stockholders receive $50 (= $110 – 60) in the expansion but nothing in the recession. The bondholders receive only $50 in the recession because there is no more money in the firm. That is, the firm simply declares bankruptcy, leaving the bondholders “holding the bag.” Thus, an increase in risk can benefit the stockholders. The key here is that the bondholders are hurt by risk, since the stockholders have limited liability. If the firm declares bankruptcy, the stockholders are not responsible for the bondholders’ shortfall. 3) Incentive to under-invest. If a company is near bankruptcy, stockholders may well be hurt if they contribute equity to a new project, even if the project has a positive NPV. The reason is that some (or all) of the cash flows will go to the bondholders. Suppose a real estate developer owns a building that is likely to go bankrupt, with the bondholders receiving

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