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  • CFM 3.4 Session 6 Financial Distress, Managerial Incentives, and Information

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    This document discusses three topics related to financial distress and managerial incentives: 1) Financial distress, which can result in bankruptcy and insolvency. It discusses the explicit costs such as legal fees and indirect costs such as lost business opportunities. Costs are generally higher for equity holders than debt holders. 2) Managerial incentives and how financial distress can affect managerial decision making. 3) Asymmetric information between managers and stakeholders and how that impacts corporate financial policies and decisions. It also includes examples of how financing decisions impact costs of equity and debt for companies like Brown Inc. and Leighton Ltd. It analyzes potential new investment projects for Leighton PLC and determines which have an internal rate of

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    This document discusses three topics related to financial distress and managerial incentives: 1) Financial distress, which can result in bankruptcy and insolvency. It discusses the explicit costs such as legal fees and indirect costs such as lost business opportunities. Costs are generally higher for equity holders than debt holders. 2) Managerial incentives and how financial distress can affect managerial decision making. 3) Asymmetric information between managers and stakeholders and how that impacts corporate financial policies and decisions. It also includes examples of how financing decisions impact costs of equity and debt for companies like Brown Inc. and Leighton Ltd. It analyzes potential new investment projects for Leighton PLC and determines which have an internal rate of

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    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
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    6 views10 pages

    CFM 3.4 Session 6 Financial Distress, Managerial Incentives, and Information

    Uploaded by

    Chineseaap
    This document discusses three topics related to financial distress and managerial incentives: 1) Financial distress, which can result in bankruptcy and insolvency. It discusses the explicit costs such as legal fees and indirect costs such as lost business opportunities. Costs are generally higher for equity holders than debt holders. 2) Managerial incentives and how financial distress can affect managerial decision making. 3) Asymmetric information between managers and stakeholders and how that impacts corporate financial policies and decisions. It also includes examples of how financing decisions impact costs of equity and debt for companies like Brown Inc. and Leighton Ltd. It analyzes potential new investment projects for Leighton PLC and determines which have an internal rate of

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPT, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 10

    CFM 3.

    4
    SESSION 6

    CHAPTER 16
    FINANCIAL DISTRESS, MANAGERIAL
    INCENTIVES, AND INFORMATION
    1. FINANCIAL DISTRESS
    2. MANAGERIAL INCENTIVES
    3. ASYMMETRIC INFORMATION
    AD 1 FINANCIAL DISTRESS

    - BANKRUPTCY
    - INSOLVENCY

    - DIRECT COSTS
    - INDIRECT COSTS
    EXPLICIT AND IMPLICIT COSTS
    COSTS DEBT EQUITY

    EXPLICIT “LOW” “HIGH”

    IMPLICIT POSITIVE NEGATIVE


    BROWN INC (WITHOUT TAXES)

    E = € 100,000,000
    D = € 100,000,000

    KE = 11%
    KD = 7%

    KO = 9%

    BROWN INC NEEDS AN ADDITIONAL € 100,000,000.


    OLD WITH WITH
    DEBT EQUITY
    EQUITY 100 100 100
    11% 13% 10%
    DEBT 100 100 100
    7% 8% 6.5%
    EQUITY 100
    NEW 10%
    DEBT 100
    NEW 8%
    CASE LEIGHTON LTD

    EARNINGS 150,000
    NO-GROWTH COMPANY
     
    EQUITY: 1,000,000 SHARES.
    SHARE PRICE IS $ 2.00.
     
    THE FIRM’S ANNUAL FREE CASH FLOW IS $
    150,000.
     
    DEBT: $ 2,000,000.
    INTEREST RATE: 6%.

     V = E + D = 4,000,000
     
    CASE LEIGHTON PLC
     
    NEW INVESTMENTS
    A $ 500,000 IRR = 12%
    B $ 500,000 IRR = 10%
    C $ 500,000 IRR = 8%
     
    FINANCE THE INVESTMENTS WITH BANK
    CREDIT: 6%.
    TAX RATE 35%
     
     
    THE COST OF EQUITY WILL INCREASE TO:
    ·         8% WHEN ATTRACTING $ 500,000
    ·         8.5% WHEN ATTRACTING $ 1,000,000
    ·         9.5% WHEN ATTRACTING $ 1,500,000
     
    QUESTION
    WHICH PROJECT(S) ARE ECONOMICALLY
    FEASIBLE?

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