A Situation That Arises When a Firm's Equity Is Close

question 29

Multiple Choice

A situation that arises when a firm's equity is close to worthless, and equity holders will prefer to invest in overly risky projects with a small chance of success rather than simply paying debt holders their regularly scheduled payments is known as a(n) :

• A) leverage problem.
• B) overinvestment problem.
• C) underinvestment problem.
• D) long position.

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Definitions:

Available-for-Sale

A classification of securities that a company holds, which can be sold in the future, not classified as held-to-maturity or trading securities.

Carrying Value

The book value of assets and liabilities on a company's balance sheet, often equating to the cost minus depreciation for assets.

Historical Cost

The original monetary value of an asset, without adjustments for inflation, depreciation, or other factors since acquisition.

Bonds

Financial instruments representing a loan made by an investor to a borrower, typically corporate or governmental, where the borrower commits to paying back the principal along with interest on a specified schedule.