Question

Custer's has bonds outstanding with a face value of $150,000 that are selling at 96 percent of par (face) value. It also has 30,000 shares of stock outstanding that are selling for $32.00 a share. The total equity value of the firm is $1,150,000. The tax rate is 20 percent. By what amount has the value of the firm been decreased by the expected bankruptcy costs? Assume there are no other claims on the firm.

A) $0
B) $30,000
C) $60,000
D) $150,000

Answer 1

The value of the firm has been decreased by the expected bankruptcy costs by the amount of the bond value.

Step-by-step explanation:

The value of the firm has been decreased by the expected bankruptcy costs by the amount of the bond value. To calculate this, we need to find the market value of the bonds, which is given as 96 percent of the face value. So the market value of the bonds is 0.96 * $150,000 = $144,000. Since there are no other claims on the firm, this is the amount by which the value of the firm has been decreased.