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The value of the ? rm if it w… Show more Dragula, Inc., ha

The value of the ? rm if it w… Show more Dragula, Inc., has debt outstanding with a face value of $3.8 million. The value of the ? rm if it were entirely ? nanced by equity would be $12.3 million. The company also has 245,000 shares of stock outstanding that sell at a price of $38 per share. The corporate tax rate is 35 percent. What is the decrease in the value of the company due to expected bankruptcy costs? 1 Capital Structure and Nonmarketed Claims Suppose the president of the company in the previous problem stated that the company should increase the amount of debt in its capital structure because of the tax-advantaged status of its interest payments. His argument is that this action would increase the value of the company. How would you respond? 2Costs of Financial Distress Steinberg Corporation and Dietrich Corporation are identical ? rms except that Dietrich is more levered. Both companies will remain in business for one more year. The companies’ economists agree that the probability of the continuation of the current expansion is 80 percent for the next year, and the probability of a recession is 20 percent. If the expansion continues, each ? rm will generate earnings before interest and taxes (EBIT) of $2.9 million. If a recession occurs, each ? rm will generate earnings before interest and taxes (EBIT) of $1,050,000. Steinberg’s debt obligation requires the ? rm to pay $900,000 at the end of the year. Dietrich’s debt obligation requires the ? rm to pay $1.3 million at the end of the year. Neither ? rm pays taxes. Assume a discount rate of 14 percent. a. What are the current market values of Steinberg’s equity and debt? What about those for Dietrich? b. Steinberg’s CEO recently stated that Steinberg’s value should be higher than Dietrich’s since the ? rm has less debt, and, therefore, less bankruptcy risk. Do you agree or disagree with this statement. • Show less

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