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:

Income Inequality

The unequal distribution of income among members of a society.

Gini Ratio

An assessment of the variation in income levels within a population, where 0 reflects equality in earnings and 1 reflects the highest possible inequality.

Income Inequality

The uneven distribution of income across various participants in an economy.

Income Inequality

The uneven distribution of income within a population, leading to a gap between the wealthiest and the poorest individuals.