A Firm with a 1,000 Stockholders Plans to Terminate Operations

question 30

Multiple Choice

A firm with a 1,000 stockholders plans to terminate operations at the end of two years. Investors are certain that the firm will generate cash flows of $1,000 at the end of the first year and $50,000 at the end of the second year. The risk-free rate is 10%. Which of the following is true, ignoring transaction costs and taxes?

• A) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will decrease if the firm borrows to increase payment at the end of the first year.
• B) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will increase if the firm borrows to increase payment at the end of the first year.
• C) The present value of these payments is $42,231 if payments of $1,000 and $50,000 are made. This present value will remain the same if the firm borrows to increase payment at the end of the first year.
• D) The present value of these payments is less than $42,231 if payments of $1,000 and $50,000 are made. This present value will change if the firm borrows to increase payment at the end of the first year. The direction of the change will depend on the type of investors that currently hold stock.
• E) There is no way to calculate present value without being given the proper discount rate for the firm. The present value would change if the firm borrows to increase payments at the end of year one.

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Definitions:

African Slave Trade

The historic practice of forcibly transporting African people to the Americas to be sold as slaves, spanning from the 16th to the 19th century.

Barbados

An island country in the Lesser Antilles of the West Indies, in the Caribbean region of North America, known for its beaches, botanical gardens, and the Harrison's Cave formation.

African Slaves

Individuals from Africa who were forcibly taken from their homeland and sold into slavery, primarily to work in the Americas on plantations and in other labor-intensive roles.