One of the factors that determine the present value (PV) of financial distress costs is ________.

Question

BlackTom AI · Accepted Answer

To analyze this question, we start by listing the given answer options and what they imply about the present value (PV) of financial distress costs.
Option A: 'costs of unpaid interest arrears' would contribute to PV only if they were expected to occur with some probability, but on their own they do not capture the likelihood of distress; this focuses more on a specific cost category rather than a probabilistic assessment.
Option B: 'loss of dividend payments' reflects opportunity costs associated with distress, yet again this is a consequence of distress rather than a driver of its PV; without a probabilistic framework, this does not determine PV by itself.
Option C: 'probability of financial distress' directly introduces the likelihood that distress occurs. In PV calculations of distress costs, the expected cost is typically the product of the cost magnitude if distress occurs and the probability that distress occurs, discounted to present value. Therefore, probability is a core driver of the PV.
Option D: 'employee compensation' is a component of operating costs or distress-related costs in some scenarios, but it is not the key determinant of PV for financial distress as a whole; it does not inherently reflect the likelihood of distress occurring, which is crucial for PV.
The reasoning behind selecting like this hinges on the standard finance principle that expected present value of a future cost equals the probability-weighted cost, discounted to present value. Thus, among the options, the factor that determines the PV of financial distress costs is the probability of financial distress, since it scales the anticipated loss to reflect both likelihood and timing.
In sum, option A misplaces emphasis on a specific cash flow without probabilistic weighting, option B misattributes the motion to opportunity costs rather than distress probability, option D identifies a cost component but not the governing probability, and option C aligns with the fundamental concept of expected discounted losses in credit risk and distress modeling.

BUSFIN 4211 SP2025 (5053) Week 12 - Practice Quiz 2

One of the factors that determine the present value (PV) of financial distress costs is ________.

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