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Run-and-Hide Detective Company currently has no debt and expects to earn $5 million in EBIT each year, for the foreseeable future. The required return on assets for detective companies of this type is 10.0 percent, and the corporate tax rate is 35 percent.
There are no taxes on dividends or interest at the personal level. Run-and-Hide calculates that there is a 5 percent chance that the firm will fall into bankruptcy in any given year.
If bankruptcy does occur, it will impose direct and indirect costs, totaling $8 million. If necessary, they will use the industry required return for discounting bankruptcy costs.
a. Compute the present value of bankruptcy costs for Run-and-Hide.
b. Compute the overall value of the fi rm.
c. Recalculate the value of the company, assuming that the firm's shareholders face a 15 percent personal tax rate on equity income.
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