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Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding. Suppose that Big Blue Banana announces plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.
-Suppose that BBB pays corporate taxes of 35% and that shareholders expect the change in debt to be permanent.Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs.If the price of BBB's stock rises to $10.85 per share following the announcement,then the present value of BBB's financial distress costs is closest to:

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Quizplus · Accepted Answer

D) V^U = $10.00 × 25 million shares = $250 million V^L = V^U + τ_cB = $250 + .35($100) = $285 million / 25 million shares = $11.40 PV of financial distress costs = ($11.40 - $10.85) × 25 million shares = $13.75 million

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