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Hominy, Inc, has debt outstanding with a face value of $4 million
Hominy, Inc, has debt outstanding with a face value of $4 million. The value of the firm if it were entirely financed by equity would be $18.6 million. The company also has 510,000 shares of stock outstanding that sell at a price of $29 per share. The corporate tax rate is 25 percent. What is the decrease in the value of the company due to expected bankruptcy costs? (Do not round intermediate calculations and enter your answer in dollars, not millions of dollars, rounded to the nearest whole dollar, e.g., 1,234,567.) Financial distress costs
Expert Solution
The financial distress cost is computed as shown below:
The value of the levered firm is computed as shown below:
= value of firm if financed entirely by equity + tax rate x face value of debt
= $ 18,600,000 + 0.25 x $ 4,000,000
= $ 19,600,000
The total market value of the firm is computed as shown below:
= Face value of debt + Number of shares outstanding x price per share
= $ 4,000,000 + 510,000 shares x $ 29
= $ 18,790,000
So, the decrease in the value of the company due to bankruptcy cost will be as follows:
= $ 19,600,000 - $ 18,790,000
= $ 810,000
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