the effect of potential bankrupcy

You then need to watch a YouTube video presentation on your chosen topic and then post the presentation summary in the dialog box. Your summary must consist of at least one paragraph of reasonable length (7-9 sentences). Your post must include the following (in this order):

1, Title (Chapter # and topic)

2. Summary of the presentation

3. Link to the video

You may, at your discretion, watch multiple videos on your chosen topic. In that case, you must provide the links to all the videos.


MM’s irrelevance results also depend on the assumption that firms don’t go

bankrupt and hence that bankruptcy costs are irrelevant. However, in practice,

bankruptcy exists, and it can be quite costly. Firms in bankruptcy have high legal

and accounting expenses, and they have a hard time retaining customers, suppliers,

and employees. Moreover, bankruptcy often forces a firm to liquidate assets

for less than they would be worth if the firm continued to operate. Assets such as

plant and equipment are often illiquid because they are configured to a company’s

individual needs and because they are difficult to disassemble and move.

Note too that the threat of bankruptcy, not just bankruptcy per se, brings about

these problems. If they become concerned about the firm’s future, key employees

start “jumping ship,” suppliers start refusing to grant credit, customers begin

seeking more stable suppliers, and lenders start demanding higher interest rates

and imposing stricter loan covenants.

Bankruptcy-related problems are likely to increase the more debt a firm has in

its capital structure. Therefore, bankruptcy costs discourage firms from pushing

their use of debt to excessive levels. Note too that bankruptcy-related costs have

two components: (1) the probability of their occurrence and (2) the costs that will

be incurred if financial distress arises. A firm whose earnings are relatively volatile,

all else equal, faces a greater chance of bankruptcy and thus should use less

debt than a more stable firm. This is consistent with our earlier point that firms

with high operating leverage (and thus greater business risk) should limit their

use of financial leverage. Likewise, firms whose assets are illiquid and would

have to be sold at “fire sale” prices should limit their use of debt financing.

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