One of the Indirect Costs of Bankruptcy Is the Incentive

question 48

Multiple Choice

One of the indirect costs of bankruptcy is the incentive toward underinvestment.Underinvestment generally would result in:

• A)the firm selecting all projects with positive NPVs.
• B)the firm turning down positive NPV projects that would clearly be accepted if the firm were all-equity financed.
• C)bondholders contributing the full amount of any new investment,but both stockholders and bondholders sharing in the benefits of those investments.
• D)shareholders making decisions based on the best interests of the bondholders.
• E)the firm accepting more projects than it would if the probability of bankruptcy was ignored.

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Definitions:

Standard Deviation

A measure of the dispersion or variability of a set of data points around the mean value, used in statistics and finance.

Correlation Coefficient

A statistical measure that calculates the strength and direction of a linear relationship between two variables on a scatterplot.

Covariance

A statistical measure of the directional relationship between the returns of two assets.

Expected Return

The mean of all potential outcomes for an investment, adjusted based on the probability of each scenario occurring.