2.322Both investors and companies employ leverage (borrowed capital) whenattempting to generate greater returns on their assets. However, using leveragedoes not guarantee success, and possible excessive losses are more likely fromhighly leveraged positions. The excessive use of leverage has attracted mediaattention as a result of its impact on shareholders as well as the public as awhole.Required:Provide a publicised example of the use of too much leverage as well as providingyour advice on what might have been done to prevent the collapse of thecompany.

2.322Both investors and companies employ leverage (borrowed capital) whenattempting to generate greater returns on their assets. However, using leveragedoes not guarantee success, and possible excessive losses are more likely fromhighly leveraged positions. The excessive use of leverage has attracted mediaattention as a result of its impact on shareholders as well as the public as awhole.Required:Provide a publicised example of the use of too much leverage as well as providingyour advice on what might have been done to prevent the collapse of thecompany.

Financial Reporting, Financial Statement Analysis and Valuation

8th Edition

ISBN:9781285190907

Author:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Publisher:James M. Wahlen, Stephen P. Baginski, Mark Bradshaw

Chapter5: Risk Analysis

Section: Chapter Questions

Problem 2QE

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4. Which of the following is false about the risk-shifting problem? Risk-shifting leads to a transfer of value from debt-holders to equity holders Risk-shifting leads prospective lenders to pay less for debt and require higher interest payments Risk-shifting arises when shareholders choose negative NPV projects with higher risk Risk-shifting is an example of an agency cost of debt Risk-shifting is greater in firms with low leverage
A Moving to another question will save this response. Question 6 According to the risk shifting (or asset substitution) hypothesis Shareholders are keen to take excessively risky projects as they do not internalize the negative externality to bondholders O Firms should never pay dividends O Companies become too conservative in their investment when debt levels are such that bankruptcy is a likely outcome O It is always optimal to reduce leverage as this reduces expected bankruptcy costs A Moving to another question will save this response. ipeg WhatsApp Image..jpeg WhatsApp Image.jpeg WhatsApp Image...jpeg WhatsApp Image..jpeg WhatsApp Im. Shot on vivo Z1x 00 16°C Mostly cloudy WIDE Vivo Al camera
2. Which of the following is false about the under-investment problem? The under-investment problem is greatest for all-equity firms Under-investment leads to a reduction in firm value Equity holders in levered firms may not invest in some positive NPV projects due to the transfer of value to debt-holders Risk-shifting leads to a transfer of value from debt-holders to equity holders Under-investment arises when shareholders forgo positive NPV projects if increase in equity value is greater than the amount to be raised
A high level of financial leverage exposes firms to default risk. However, as a result of it, shareholders of the firm expect high potential returns. Select one: True False
5.(True or False) Risk shifting refers to a situation in which management of a firm with risky debt cannot fund a positive NPV project with equity because equityholders understand that some of the returns of the positive NPV project go to debtholders
Choose all statement(s) that is (are) FALSE. Select one or more alternatives: One advantage of using leverage is that it allows the original owners of the firm to maintain their equity stake. One disadvantage of using leverage is that it always reduces the expected return to equity owners of the firm. In a highly-leveraged firm, an over-investment problem could occur when shareholders choose to invest in a negative-NPV project which reduces the debtholders value. In a highly-leveraged firm, an under-investment problem could occur when shareholders choose to invest in a negative-NPV project which reduces the debtholders value.
A6) Finance Which one of the following statements is not correct? a) Market timing theory argues that companies issue equity when their P/E ratio is exceptionally high b) According to static trade-off theory agency costs of equity increase when CEO’s ownership of the firm is low c) Firm has no target capital structure if it follows the pecking order theory d) Home-made leverage is possible when no market imperfections exist
Regarding the EPS fallacy, which of the following statements is correct: a. When a company issues debt and uses all the proceeds to buy back equity and as a result EPS rises, the fact that some analysts associate the rise of EPS to an improvement in the company's performance is called the EPS fallacy. b. All given statements are correct. c. One of the reasons behind the EPS fallacy is not to take into account that when EPS rises mechanically due to a leveraged recapitalisation, the cost of equity also rises in the same proportion and the share price does not change (assume no taxes and perfect capital markets world). d. Suppose companies A and B have identical cash flows but different capital structures. Suppose further that EPS(A) > EPS(B). We cannot conclude that A has a better performance than B.
Which of the following statements is FALSE? A. Equity cost of capital is normally higher then cost of debt, thus cost of debt can be examined in isolation. B. No matter if a firm is unlevered or levered, there is no difference in the market value of the firms total securities and market value of the firm’s assets. C. Introducing debt increases the risk even though it may be cheap and consequently increases firms equity cost of capital. D. Cost of Capital of equity and Leverage can be explicitly explained by first proposition that Modigliani and Miller introduced.
The use of financial leverage by the firm has a potential impact on which of the following? (1) The risk associated with the firm's operations. (2) The risk experienced by the stockholders (3) The variability of operating income (4) The variability of net income (5) The probability of going bankrupt Group of answer choices: 1, 2, 3 1, 3, 5 3, 4, 5 2, 3, 4 2, 4, 5
Which of the following statement is false? a. None of above b. The capital structure should be flexible. c. A firm having operating loss would find it worthwhile to incorporate debt in the capital structure in a greater measure. d. The use of excessive debt threatens the solvency of the company.
The weak form of the efficient market hypothesis implies that: CHOOSE ONE A. Investors can achieve abnormal returns, on average, using technical analysis, after adjusting for transaction costs and taxes. B. Insiders, such as specialists and corporate board members, cannot achieve abnormal returns on average. C. No one can achieve abnormal returns using market information. D. NONE OF THE ABOVE