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This post addresses the present value of financial distress

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Use the information for the question(s) below. Provide step by step calculations for each.

Big Blue Banana (BBB) is a clothing retailer with a current share price of $10.00 and with 25 million shares outstanding. Suppose that Big Blue Banana announces plans to lower its corporate taxes by borrowing $100 million and using the proceeds to repurchase shares.

Suppose that BBB pays corporate taxes of 35% 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 BBB's stock rises to $10.85 per share following the announcement , then the present value of BBB's financial distress costs is closest to:

A. $35.00 million
B. $11.40 million
C. $13.75 million
D. $21.25 million

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Solution Summary

The solution provides the correct answer with all calculations to support the answer, explaining the total present value of BBB's financial distress costs. Step by step calculations are given for each problem.

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