When Financial Disaster Is Looming, Management May Borrow to Invest

question 46

Multiple Choice

When financial disaster is looming, management may borrow to invest in projects having a negative expected NPV because:

• A) the firm's beta is now negative.
• B) taxes are no longer a concern.
• C) the interest tax shield will cover the loan costs.
• D)the lender bears all the risk.

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Definitions:

Put Option

This is a financial deal which provides the participant the freedom, but not the compulsion, to part with a given amount of a principal asset at an established cost during a set span.

Market Price

The existing rate at which a service or asset is available for buying or selling in a market environment.

Put Option

A contractual financial arrangement allowing the option holder to sell a designated quantity of an underlying asset at a fixed price before a certain deadline, without any compulsory action.

Strike Price

The fixed price at which the holder of an option can buy (in the case of a call option) or sell (in the case of a put option) the underlying asset.