LOS f: Compare and contrast the risks of creditors and owners.

Q1. Which of the following statements concerning a firm's creditors and equity holders is most accurate?

A)   In a bankruptcy liquidation, creditors and equity holders will divide the remaining assets of the business proportionately to their claims.

B)   In the event of bankruptcy, equity holders are not legally entitled to receive anything unless creditors are paid in full.

C)   The priority claim of equity holders gives them more safety than creditors if bankruptcy occurs.

Q2. Which of the following describes an advantage that equity holders of a business have over creditors?

A)   Dividend payments are more reliable than interest payments.

B)   Priority claim on assets in the event of bankruptcy.

C)   Ability to hire or fire managers.

LOS f: Compare and contrast the risks of creditors and owners. fficeffice" />

Q1. Which of the following statements concerning a firm's creditors and equity holders is most accurate?

A)   In a bankruptcy liquidation, creditors and equity holders will divide the remaining assets of the business proportionately to their claims.

B)   In the event of bankruptcy, equity holders are not legally entitled to receive anything unless creditors are paid in full.

C)   The priority claim of equity holders gives them more safety than creditors if bankruptcy occurs.

Correct answer is B)

Creditors have a priority claim on the assets of a business in the event of bankruptcy. This means that if bankruptcy occurs, the assets of the firm will go to creditors and equity holders will receive what is left over. Equity holders are not entitled to receive anything unless creditors are paid in full.

Q2. Which of the following describes an advantage that equity holders of a business have over creditors?

A)   Dividend payments are more reliable than interest payments.

B)   Priority claim on assets in the event of bankruptcy.

C)   Ability to hire or fire managers.

Correct answer is C)

Equity holders of a business receive what is left over after all expenses, including interest and principal payments on debt, have been paid. The return for equity holders is much less certain than the return for creditors, but in exchange for this risk, equity holders have decision power of the business, which includes firing and hiring managers, and declaring what portion of earnings will be paid out as dividends. Note that creditors have a priority claim on assets in the event of bankruptcy.

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