Flimsy Construction Inc.generates perpetual annual EBIT of $500.The cost of unlevered equity for Flimsy is 10%.The corporate tax rate is 35%.Flimsy has 300 shares outstanding that trade for $6.89.Flimsy has debt worth $1,512.What is the present value of financial distress costs for Flimsy? Assume that there are no other market imperfections other than costs of bankruptcy.

Question

Quizplus · Accepted Answer

V_L = V_U + T × D - PV(Financial Distress Costs) V_L = E + D V_L = $6.89 × 300 + $1,512 = $3,579 PV(Financial Distress Costs) = V_U + T × D - V_L PV(Financial Distress Costs) = $500 × (1 - 0.35)/0.10 + 0.35 × $1,512 - $3,579 PV(Financial Distress Costs) = $3,250 + $529.2 - $3,579 PV(Financial Distress Costs) = $3,779 - $3,579 = $200