Do you think a corporation must actually declare bankruptcy to incur costs associated with financial distress?...

Do you think a corporation must actually declare bankruptcy to incur costs associated with financial distress? Could rumors of financial problems lead to costs? How would these costs lower firm value? Explain your answers.

Expert Solution

No, firm can also Incur indirect insolvency cost which are related to all such opportunity gain lost and all such gains which has been eroded by the company because of financial distress.

Yes, the rumours of financial problem will mean that the company is not going to get various kinds of borrowing and it will have to face the risk of loss of revenue loss due to risk related to financial distress because of indirect costs associated with the financial distress.

These cost will lower the firm value because the firm will not be getting adequate loans and it will also not be getting adequate investment from the share holders and it will be hampered with various opportunities from the legal authorities so the company will not be having an adequate amount of free run on upside to expand itself because its options will be Limited as there is a rumour related to the insolvency and stakeholders will be sceptical about the survival so it will be lowering the overall value of the company in the market also because market participants will value the company lower

jeff jeffy answered 2 years ago

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