An all-equity public firm has a current share price of £8 and 25 million shares outstanding. Suppose that the firm announces plans to lower its corporate taxes by borrowing £100 million and using the proceeds to repurchase shares. The change of capital structure is not affecting the book value of assets of the firm. Suppose that the firm pays corporate taxes of 40% and that shareholders expects the change in debt to be permanent. Assume that capital markets are perfect except for the existence of corporate taxes and financial distress costs. 

If the price of the firm’s stock rises to £10.6 per share following the announcement, what is the present value of the firm’s financial distress costs?

Answer rating: 100% (QA)

Calculating the Present Value of Financial Distress Costs In this scenario the increase in the firms stock price following the announcement can be att... View the full answer