Question

1. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? 1 is the highest claim, 5 is the lowest.

(1)	Trustees' costs to administer and operate the firm.
(2)	Common stockholders.
(3)	General, or unsecured, creditors.
(4)	Secured creditors, who have a claim to the proceeds from the sale of specific property pledged to secure a loan.
(5)	Taxes due to federal and state governments.

a.	5, 4, 1, 3, 2
b.	4, 1, 5, 3, 2
c.	5, 1, 4, 2, 3
d.	1, 5, 4, 3, 2
e.	1, 4, 3, 5, 2

2. Commodore Corporation is deciding whether to invest in a project today or to postpone the decision until next year. The project has a positive expected NPV, but its cash flows could be less than expected, in which case the NPV could be negative. No competitors are likely to invest in a similar project if Commodore decides to wait. Which of the following statements best describes the issues that Commodore faces when considering this investment timing option?

1.    The investment timing option does not affect the cash flows and will therefore have no impact on the project’s risk.
2.    The more uncertainty about the future cash flows, the more logical it is for Commodore to go ahead with this project today.
3.    Since the project has a positive expected NPV today, this means that its expected NPV will be even higher if it chooses to wait a year.
4.    Since the project has a positive expected NPV today, this means that it should be accepted in order to lock in that NPV.
5.    Waiting would probably reduce the project’s risk.

3. Which one of the following is an example of a “flexibility” option?

1.    A company has an option to invest in a project today or to wait a year.
2.    A company has an option to close down an operation if it turns out to be unprofitable.
3.    A company agrees to pay more to build a plant in order to be able to change the plant’s inputs and/or outputs at a later date if conditions change.
4.    A company invests in a project today to gain knowledge that may enable it to expand into different markets at a later date.
5.    A company invests in a jet aircraft so that its CEO, who must travel frequently, can arrive for distant meetings feeling less tired than if he had to fly commercial.

Answer 1

1. Option B 4, 1, 5, 3, 2

The correct order is

1. Secured Creditors

2. Trustees Costs

3. Government Taxes Payable

4. Unsecured Creditors

5. Common Stock holders'

2. Option E. Waiting would probably reduce the project’s risk

we cannot actually tell whether the company's NPV is going to be negative under current circumstances but waiting for 1 year will help to understand business better and it will reduce risk

3. Option C. A company agrees to pay more to build a plant in order to be able to change the plant’s inputs and/or outputs at a later date if conditions change

Flexibility options is an option where the company can change the project inputs and outputs with flexibility

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