Present value of the bankruptcy cost for the unlevered firm

Assignment Help Financial Management

Reference no: EM131060560

The unlevered firm expects to earn $250,000 in net operating income each year for the foreseeable future. It has a tax rate of 40% and has a capitalization rate of 8% equal to the industry required return for this type of firm. It calculates that there is a 10% chance the firm will fall into bankruptcy in any given year and that, if bankruptcy does occur, it will impose direct and indirect costs totaling $48,000. Assume that, in the event of bankruptcy, the firm will reorganize and continue operations indefinitely, with a constant 10% probability of reentering bankruptcy. If necessary, use the industry required return for discounting bankruptcy costs. Assume that the firm considers borrowing $500,000 debt at an interest rate 5% and use the proceeds to repurchase an equal amount of outstanding stock. With this level of debt, the likelihood of falling into bankruptcy in any given year increases to 15%, and if bankruptcy occurs then it will impose direct and indirect costs totaling $48,000. What is the present value of the bankruptcy cost for the unlevered firm if no debt is used?

Reference no: EM131060560

Questions Cloud

Considering the purchase of new log flume ride : The Ocean City water park is considering the purchase of a new log flume ride. The cost to purchase the equipment is 3,500,000 and it will cost an additional 250,000 to have it installed. Using the Goal Seek tool, calculate the minimum ticket price t..

Problem regarding the major labor laws : Using APA style format, write a paper of 4-5 pages describing the provisions of the following major labor laws as well as their impact on organizations and the union-management relationship:

What would happen to the expected maturity of the class : If a CMO has 3 tranches, A, B, and Z (an accrual tranche), as well as a residual class, answer the following question? If the prepayment on a pool of mortgages decreases from CPR 10% to CPR 5%, what would happen to the expected maturity of the A clas..

What is the objective of tcp congestion control : For congestion control, TCP uses methods like AIMD (Additive increase, multiplicative decrease), slow start and congestion avoidance.

Present value of the bankruptcy cost for the unlevered firm : The unlevered firm expects to earn $250,000 in net operating income each year for the foreseeable future. It has a tax rate of 40% and has a capitalization rate of 8% equal to the industry required return for this type of firm. What is the present va..

Draw the tree after each insertion : Insert, into an empty binary search tree, entries with keys 30, 40, 24, 58, 48, 26, 11, 13 (in this order). Draw the tree after each insertion.

What is the current price of the stock : A company will pay a $5 per share dividend in 1 year. The dividend in 2 years will be $7 per share, and it is expected that dividends will grow at 5% per year thereafter. The expected rate of return on the stock is 13%. What is the current price of t..

Theories of interest rate determination : You are a financial analyst for the CMC Corporation. This corporation predicts changes in the economy, such as interest rates, retail trends, and unemployment. Your job is to educate incoming analyst on the terminology, definitions, and uses of in..

What was the standard deviation-arithmetic average : You’ve observed the following returns on Crash-n-Burn Computer’s stock over the past five years: 12 percent, –12 percent, 19 percent, 24 percent, and 10 percent. a. What was the arithmetic average return on Crash-n-Burn’s stock over this five-year pe..

User Account

All Pages