HW20ProblemsCh172011Ed1 Compatibility Mode Draw Design layou

HW%20Problems-Ch17%20-11Ed[1] -Compatibility Mode Draw Design layout References Mailings Review View Add-ins Help ??me what you want to do AaBbCeDe AaBbccDe AaBbC AaBbcel Aa :-. o.-\'11Normal ||No Spac. Heading 1 Heading 2 Title -|10 ·A\' A\' Aa· ?·-·-·-·-- Font Paragraph Styles 3. Nonmarketed Claims Dream, Inc., has debt outstanding with a face value of $5 million. The value of the firm if it were entirely financed by equity would be $18.65 million. The company also has 360,000 shares of stock outstanding that sell at a price of SAl per share. The corporate tax rate is 35 percent. What is the decrease in the value of the company due to expected bankruptcy costs? //s4 //%5 ll e ll. 7 II. 8 W 91) s 3 6

Solution

Value of levered firm (if financed by equity) = equity + debt * tax rate

= 18650000 + 5000000 * 0.35

= 18650000 + 1750000

= 20400000

Total market value of firm = debt + equity

= $5000000 + 360000 * $41

= $5000000 + $14760000

= $19760000

Now, the difference between the total value of firm and total leverage firm will be the non-marketed claims value

  Total value of firm =Value of levered firm - non-marketed claims value

$19760000 =  20400000 - value of non marketed claims (bankruptcy cost)

value of non marketed claims (bankruptcy cost) = $640000