(SOLVED) Dream Inc. has debt outstanding with a face value of $6 million and a market value of $5 million.

Question

Dream Inc. has debt outstanding with a face value of $6 million and a market value of $5 million. The value of the firm if it were entirely financed by equity would be $15 million. The company also has 300,000 shares of stock outstanding that sell at a price of $35 per share. The corporate tax rate is 40 percent.

What is the decrease in the value of the company due to expected bankruptcy costs?

Expert Solution Preview

According to Modigliani and Miller theory 1 with taxes we can calculate the value of the levered firm which is given by:

Vl = $17,400,000

We can also calculate the total market value of the firm Vt by adding the debt (B) with the total equity (SV)

Vt= $16,500,000

Then the decrease in the value of the company due to bankruptcy

Vb =.....