Which of the Following Statements Is NOT an Example of the Agency

question 70

Multiple Choice

Which of the following statements is NOT an example of the agency cost of debt?

• A) ABC Company shareholders pressure management to invest in very risky projects in hopes that one of the investments might pay off. The company is highly leveraged, so shareholders have little to lose.
• B) ABC Company has a large amount of debt but very few investment opportunities. The board of directors decides to pay out a large special dividend, and the company subsequently enters insolvency. Lenders collect about 60 per cent of the face value of the debt.
• C) ABC Company is very close to financial distress. The company has a positive-NPV investment opportunity, but even with the project the company is likely to enter insolvency. Investors refuse to invest the additional funds necessary to pursue the project, even though it has a positive NPV.
• D) Investors are unsure of the value for ABC Company. ABC Company decides to issue equity to pay down debt. The market assumes that ABC Company's managers are issuing equity because they think that the company's shares are overvalued. As a result, the company's share price falls when the equity issue is announced.

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Definitions:

Compensating Balance

A requirement by some banks requiring depositors to maintain minimum cash balances in their bank accounts.

Petty Cash Fund

A special cash fund to pay relatively small amounts.

Bank Checking Account

A bank account that allows individuals and businesses to deposit money and withdraw funds, which can be accessed using checks, automated teller machines (ATMs), and electronic debits.

Cash Equivalents

Highly liquid investments that are usually reported with cash on the balance sheet.