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Dream, Inc., has debt outstanding with a face value of $6 million. The value of the firm if it were entirely financed by equity would be $18.25 million. The company also has 440,000 shares of stock outstanding that sell at a price of $32 per share. The corporate tax rate is 35 percent. What is the decrease in the value of the company due to expected bankruptcy costs? (Enter your answer in dollars, not millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

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ayokenny2001

Answer:

$955,000

Explanation:

According to the Modigliani and Miller theory, we can calculate the value of the levered firm which is denoted by;

VI = Vu + tB

VI = 18.25million + 0.35(6million)

VI = 20.35 million

We can also calculate the total market value of the firm Vt by adding the debt (B) with the total equity (SV)

Vt = B + SV

Vt = 5 million + 440,000(32)

Vt = 5 million + 14.80 million

Vt = 19.80 million

Then the decrease in the value of the company due to bankruptcy is

Vb = VI - Vt

Vb = 20.35 million - 19.80 million

VB = $955,000

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