Test Bank Chapter 22 – Insolvency And Financial Distress - Corporate Finance Asia Pacific 2e Complete Test Bank by Chris Adam. DOCX document preview.
Chapter 22 – Insolvency and financial distress
MULTIPLE CHOICE
1. In a business failure, when a company’s liabilities exceed the fair market value of its assets, this is called a(n):
a. | economic failure |
b. | technical insolvency |
c. | insolvency |
d. | business failure |
REF: 22.1 Insolvency and Business Failure NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
2. A company that does not pay its debts when they come due is called:
a. | insolvent |
b. | debtor in possession |
c. | broke |
d. | financially distressed |
REF: 22.2 Insolvency Processes NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
3. A creditor that has a specific asset pledged as collateral is called a(n):
a. | secured creditor |
b. | unsecured creditor |
c. | general creditor |
d. | shareholder |
REF: 22.3 Priority of Claims NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
Exhibit 22-1
Unsecured creditors’ claims | Case I | Case II | Case III | |
Unpaid balance on second mortgage | $ 350 000 | $ 600 000 | $ 250 000 | |
Accounts payable | 150 000 | 350 000 | 75 000 | |
Notes payable | 2 500 000 | 3 250 000 | 750 000 | |
Subordinated debentures | 1 250 000 | 2 250 000 | 1 250 000 | |
Total | $4 250 000 | $6 450 000 | $2 325 000 | |
4. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what percentage of its claims are going to be satisfied if Case I occurs?
a. | 100.00% |
b. | 70.59% |
c. | 29.41% |
d. | 82.35% |
3 500 000/4 250 000 = 0.8235
PTS: 1 DIF: E
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
5. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what percentage of its claims are going to be satisfied if Case II occurs?
a. | 70.59% |
b. | 54.26% |
c. | 100% |
d. | 46.51% |
3 500 000/6 450 000 = 0.5425
PTS: 1 DIF: E
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
6. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what percentage of its claims are going to be satisfied if Case III occurs?
a. | 129.03% |
b. | 100% |
c. | 82.56% |
d. | 17.44% |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
7. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what settlement will holders of the notes payable receive in Case I?
a. | $1 764 706 |
b. | $ 2 058 750 |
c. | $735 250 |
d. | $1 326 690 |
3 500 000/4 250 000 = 0.8235
2 500 000(0.8235) = 2 058 750
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
8. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what settlement will holders of the subordinated debentures receive in Case II?
a. | $2 250 000 |
b. | $1 203 525 |
c. | $1 046 512 |
d. | $ 1 220 850 |
3 500 000/6 450 000 = 0.5426
2 250 000(0.5426) = 1 220 850
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
9. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what settlement will holders of the subordinated debentures receive in Case III?
a. | $1 250 000 |
b. | $958 250 |
c. | $745 400 |
d. | $1 075 268 |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
10. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what settlement will holders of the subordinated debentures receive in Case I?
a. | $1 050 534 |
b. | $1 250 000 |
c. | $1 029 375 |
d. | $882 353 |
3 500 000/4 250 000 = 0.8235
1 250 000(0.8235) = 1 029 375
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
11. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, what settlement will holders of the accounts payables receive in Case II?
a. | $162 791 |
b. | $187 209 |
c. | $350 000 |
d. | $189 910 |
3 500 000/6 450 000 = 0.5426
350 000(0.5426) = 189 910
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
12. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, how much do the owners of the company receive in Case I?
a. | $125 678 |
b. | $0 |
c. | $357 250 |
d. | $475 000 |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
13. Refer to Exhibit 22-1. If the company has $3 500 000 in funds to distribute to unsecured creditors, how much do the owners of the company receive in Case III?
a. | $675 000 |
b. | $0 |
c. | $ 1 175 000 |
d. | $175 000 |
3 500 000 – 2 325 000 = 1 175 000
PTS: 1 DIF: E
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
14. Refer to Exhibit 22-1. If the company has $2 534 000 in funds to distribute to unsecured creditors, what percentage of its claims are going to be satisfied if Case I occurs?
a. | 26.32% |
b. | 40.38% |
c. | 100% |
d. | 59.62% |
2 534 000/4 250 000 = 0.5962
PTS: 1 DIF: E
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
15. Refer to Exhibit 22-1. If the company has $4 268 000 in funds to distribute to unsecured creditors, what percentage of its claims are going to be satisfied if Case II occurs?
a. | 100% |
b. | 33.83% |
c. | 66.17% |
d. | 46.23% |
4 268 000/6 450 000 = 0.6617
PTS: 1 DIF: E
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial markets and interest rates
16. Refer to Exhibit 22-1. If the company has $578 000 in funds to distribute to unsecured creditors, what percentage of its claims are going to be satisfied if Case III occurs?
a. | 24.86% |
b. | 75.14% |
c. | 100% |
d. | 56.35% |
578 000/2 325 000 = 0.2486
PTS: 1 DIF: E
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial markets and interest rates
17. Refer to Exhibit 22-1. If the company has $2 456 000 in funds to distribute to unsecured creditors, what settlement will holders of the notes payable receive in Case I?
a. | $1 444 706 |
b. | $2 500 000 |
c. | $1 055 294 |
d. | $1 863 685 |
2 456 000/4 250 000 = 0.5779
2 500 000(0.5779) = 1 444 706
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial markets and interest rates
18. Refer to Exhibit 22-1. If the company has $5 245 000 in funds to distribute to unsecured creditors, what settlement will holders of the subordinated debentures receive in Case II?
a. | $420 300 |
b. | $1 829 700 |
c. | $2 250 000 |
d. | $1 256 200 |
5 245 000/6 450 000 = 0.8132
2 250 000(0.8132) = 1 829 700
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial markets and interest rates
19. Refer to Exhibit 22-1. If the company has $4 152 000 in funds to distribute to unsecured creditors, how much do the owners of the company receive in Case I?
a. | $0 |
b. | $98 000 |
c. | $128 000 |
d. | $253 000 |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial markets and interest rates
20. Refer to Exhibit 22-1. If the company has $2 475 000 in funds to distribute to unsecured creditors, how much do the owners of the company receive in Case III?
a. | $75 000 |
b. | $0 |
c. | $150 000 |
d. | $225 000 |
2 475 000 – 2 325 000 = 150 000
PTS: 1 DIF: M
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
21. Bavarian Sausages has a working capital/total assets ratio of 0.8, a retained earnings/total assets ratio of 0.2, an EBIT/total assets ratio of 0.34, a market value of equity/book value of equity ratio of 1.2, and a sales/total assets ratio of 0.75. What is the company’s Z score?
a. | 3.25 |
b. | 2.78 |
c. | 1.65 |
d. | 3.83 |
1.2(0.8) + 1.4(0.2) + 3.3(0.34) + 0.6(1.2) + 0.75 = 3.83
PTS: 1 DIF: E
REF: 22.4 Predicting Insolvency NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
Use the following information to answer questions 22 to 25.
Needsalift, Inc. has $10 million in funds to distribute to its unsecured creditors. Two sets of possible claims are presented below.
Case I | Case II | |
Unsecured bonds | $ 2 million | $ 4 million |
Notes payable to bank | $ 6 million | $ 2 million |
Accounts payable | $ 4 million | $ 6 million |
Unpaid balance of second mortgage | $ 2 million | $ 6 million |
$14 million | $18 million |
22. For Case I, how much will the bank receive for its notes payable claim?
a. | $3.75 million |
b. | $4.29 million |
c. | $6.00 million |
d. | $0 |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
23. For Case I, what settlement will unsecured bondholders receive?
a. | $0 |
b. | $2 million |
c. | $1.43 million |
d. | $1 million |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
24. For Case II, what settlement will unsecured bondholders receive?
a. | $4 million |
b. | $3.25 million |
c. | $2.22 million |
d. | $0 |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
25. For Case II, what settlement will accounts payable holders receive?
a. | $3 million |
b. | $3.34 million |
c. | $4.65 million |
d. | $6 million |
REF: 22.3 Priority of Claims NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
26. Which factor in the Z-score model will most affect the likelihood of a predicted bankruptcy?
a. | Working capital/total assets ratio |
b. | EBIT/ total assets ratio |
c. | Market value of equity/book value of equity ratio |
d. | Retained earnings/total assets ratio |
REF: 22.4 Predicting Insolvency NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
27. Suppose a company has a Z score of 1.6, and the following financial characteristics: working capital/total assets ratio of 0.05, retained earnings/total assets ratio of 0.10, market value of equity/book value of equity ratio of 1.1 and sales/total assets ratio of 0.4. What must be its EBIT/total assets ratio?
a. | 0.15 |
b. | 0.10 |
c. | 0.05 |
d. | 0.0 |
REF: 22.4 Predicting Insolvency NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
28. Gizmo Co. has a Z score of 2.3 based on its most recent financial information. This indicates that:
a. | Gizmo has a high probability of failure |
b. | Gizmo has a low probability of failure |
c. | Gizmo’s probability of failure is uncertain |
d. | nothing; a Z score does not predict company failure |
REF: 22.4 Predicting Insolvency NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
29. Gizmo Co. has a Z score of 1.2 based on its most recent financial information. This indicates that:
a. | Gizmo has a high probability of failure |
b. | Gizmo has a low probability of failure |
c. | Gizmo’s probability of failure is uncertain |
d. | nothing; a Z score does not predict company failure |
REF: 22.4 Predicting Insolvency NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
30. Gizmo Co. has a Z score of 3.0 based on its most recent financial information. This indicates that:
a. | Gizmo has a high probability of failure |
b. | Gizmo has a low probability of failure |
c. | Gizmo’s probability of failure is uncertain |
d. | nothing; a Z score does not predict company failure |
REF: 22.4 Predicting Insolvency NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
31. Gizmo Co. has the following financial measures: working capital/total assets ratio of 0.05, retained earnings/total assets ratio of 0.10, EBIT/total assets ratio of 0.3, market value of equity/book value of equity ratio of 1.1 and sales/total assets ratio of 0.4. What is Gizmo’s Z score?
a. | 2.40 |
b. | 2.35 |
c. | 2.30 |
d. | 2.25 |
REF: 22.4 Predicting Insolvency NAT: Analytic skills
LOC: acquire knowledge of financial analysis and cash flows
32. Financial distress:
a. | always leads to bankruptcy |
b. | imposes direct and indirect costs on a company |
c. | has no effect on a company’s customers |
d. | has no effect on a company’s reputation |
REF: 22.1 Insolvency and Business Failure NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
33. The legal mechanism by which inefficient companies may leave the market is:
a. | economic Darwinism |
b. | bankruptcy |
c. | liquidation |
d. | dilution of secured claims |
REF: 22.1 Insolvency and Business Failure NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
34. If a car manufacturer were to fail in an economic downturn, then it would fail due to:
a. | economic activity |
b. | corporate maturity |
c. | an overly conservative capital structure |
d. | an aggressive capital structure |
REF: 22.1 Insolvency and Business Failure NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
35. Winding up a company’s operations, selling off its assets and distributing the proceeds to creditors is called:
a. | reorganisation |
b. | liquidation |
c. | dissolution |
d. | auction |
REF: 22.2 Insolvency Processes NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
36. Liquidation is seen as a means of:
a. | providing breathing space to viable companies that are in temporary financial distress |
b. | winding up the operations of companies that are not economically viable |
c. | punishing management of companies that have defrauded shareholders |
d. | creating a structure within the companies |
REF: 22.2 Insolvency Processes NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
37. Bank A has debt that is backed with secured assets of Company B, which is currently liquidating its assets in bankruptcy. If Bank A is owed $10 000 000 and the liquidation of the assets will provide $8 000 000, then what happens to the remaining $2 000 000?
a. | The $2 000 000 will be lost in the bankruptcy process. |
b. | The $2 000 000 will have to be repaid through the automatic securitisation of other assets. |
c. | The $2 000 000 will become an unsecured or general credit amount in the liquidation process. |
d. | The $2 000 000 will be paid to shareholders. |
REF: 22.3 Priority of Claims NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
38. Within Altman’s Z-score model of predicting bankruptcy, the total value of the assets is included in the model. If the total value of the assets decreases, what effect does that have on the probability of a company being in bankruptcy?
a. | Increases |
b. | Remains the same |
c. | Decreases |
d. | There is not enough information to answer this question. |
REF: 22.4 Predicting Insolvency NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
39. Within Altman’s Z-score model of predicting bankruptcy, working capital is included in the model. If working capital increases, what affect does that have on the probability of a company being in bankruptcy?
a. | Increases |
b. | Remains the same |
c. | Decreases |
d. | There is not enough information to answer this question. |
REF: 22.4 Predicting Insolvency NAT: Reflective thinking
LOC: acquire knowledge of financial analysis and cash flows
40. Which of the following terms describes the bankruptcy process designed to allow businesses that are in temporary financial distress but are worth saving to continue operating while the creditors’ claims are settled using a collective procedure?
a. | Insolvency |
b. | Workout |
c. | Voluntary settlement |
d. | Reorganisation |
e. | Extension |
REF: 22.2 Insolvency Processes NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
41. Which of the following was the largest bankruptcy in the US history?
a. | Enron Corp. |
b. | Texaco |
c. | Lehman Brothers |
d. | Chrysler |
REF: 22.1 Insolvency and Business Failure NAT: Reflective thinking
LOC: acquire knowledge of financial markets and interest rates
SHORT ANSWER
1. What is the difference between financial distress and insolvency?
PTS: 1 DIF: E
REF: 22.1 Insolvency and Business Failure
2. List the priority of claims in insolvency.
PTS: 1 DIF: E
REF: 22.3 Priority of Claims
3. What are the guidelines for classifying businesses using the Z score?
PTS: 1 DIF: E
REF: 22.4 Predicting Insolvency
4. How useful is the Z score in predicting insolvency?
PTS: 1 DIF: E
REF: 22.4 Predicting Insolvency
5. What are the options available to companies in insolvency?
PTS: 1 DIF: E
REF: 22.2 Insolvency Processes
6. Briefly explain voluntary administration.
PTS: 1 DIF: E
REF: 22.1 Insolvency and Business Failure