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23 May, 05:00

Charisma, Inc., has debt outstanding with a face value of $6.2 million. The value of the firm if it were entirely financed by equity would be $29.9 million. The company also has 425,000 shares of stock outstanding that sell at a price of $58 per share. The corporate tax rate is 22 percent. What is the decrease in the value of the company due to expected bankruptcy costs

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  1. 23 May, 07:21
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    Decrease in value of company due to expected bankruptcy cost = $414,000

    Explanation:

    As per the data given in the question,

    According to M & M proportional I with taxes,

    Levered firm value is = Equity + Debt

    = $29,900,000 + 0.22 * $6,200,000

    = $31,264,000

    Market value of the firm = market value of debt + market value of equity

    = $6,200,000 + 425,000 * $58

    = $30,850,000

    Decrease in value of company due to expected bankruptcy cost = $31,264,000 - $30,850,000

    = $414,000
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