6. Petroles Vintage Wine Company is presently family owned and has no debt.

The Petroles family is considering going public by selling some of their stock in the company. Investment bankers tell them the total market value of the company is $10 million if no debt is employed. In addition to selling stock, the family wishes to consider issuing debt that, for computational purposes, would be perpetual. The debt then would be used to purchase stock, so the size of the company would stay the same. Based on various valuation studies, the net tax advantage of debt is estimated at 22 percent of the amount borrowed when both corporate and personal taxes are taken into account. The investment banker has estimated the following present values for bankruptcy costs associated with various levels of debt:

Debt (in Millions)

Present Value of Bankruptcy Costs 0

$ 50,000 100,000 200,000 400,000 700,000 1,100,000 1,600,000 Given this information, what amount of debt should the family choose?

Chapter 9 Theory of Capital Structure 283