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Bontron Belgian Fashions (BBF) is a clothing retailer with a current share price of $10
Bontron Belgian Fashions (BBF) is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding.
Suppose that BBF plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.
BBF pays corporate taxes of 40% and its shareholders expect the change in debt to be permanent.
The price of BBF's stock rises to $10.80 per share following the announcement.
What is the present value of BBF's financial distress costs?
Expert Solution
Computation of Present Value of BBF's Financial Distress Costs:
Value of all equity financed firm (VU) = $10 * 25 Million Shares = $250 MILLION
Value of Levered Firm (VL) = Value of all equity financed firm (VU) + Debt*Tax Rate = $250 Millions + $100 Millions*40%
= 250 Million + $40 Millions
= $290 Millions
Value after Announcement = $10.80*25 million shares = $270 millions
Present Value of BBF's Financial Distress Costs = $290 millions - $270 millions = $20 millions
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