A firm with no debt has a current market value of $50 million. It borrows $10 million at 12%. Management estimates the present value of associated bankruptcy and agency costs at $2.5 million. If the company’s tax rate is 30%, what is its new market value?
A firm with no debt has a current market value of $50 million. It borrows $10 million at 12%. Management estimates the present value of associated bankruptcy and agency costs at $2.5 million. If the company’s tax rate is 30%, what is its new market value?
Market value = $50,000,000 – $2,500,000 + ($10,000,000)(0.12)(0.30)/0.12
= $50,500,000
The new market value increases because of a $3 million tax-shield benefit, but is then reduced by a $2.5 million increase in bankruptcy and agency costs
