Question

Hornqvist, Inc., has debt outstanding with a face value of $4
million. The value of the firm if it were entirely financed by
equity would be $18.65 million. The company also has 520,000 shares
of stock outstanding that sell at a price of $30 per share. The
corporate tax rate is 35 percent. What is the decrease in the value
of the company due to expected bankruptcy costs? **(Do not
round intermediate calculations. Enter your answer in dollars, not
millions of dollars, e.g., 1,234,567.)**

Financial distress costs
$

Answer #1

**Answer :**

As per Modigliani and Miller proposition I with taxes -

Value of levered firm = Value of unlevered firm + Debt * tax rate

= $ 18,650,000 + $ 4,000,000 * 0.35

= $ 20,050,000

And, Market value of firm = Market price per share * number of shares + Value of debt

= $ 30 * 520,000 + 4,000,000 = $ 19,600,000

Therefore,

**Financial distress costs = $ 20,050,000 - $ 19,600,000 =
$ 450,000**

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