Ground Hog Day, Inc., an unlevered firm, has one million shares of stock outstanding at a price of $15 per share. (The firms tax rate is 35%.). The stock has a beta of 1.2, and the risk-free rate is 8%. (Assume that market risk premium = 6%.). Management is considering the use of debt ranging from $2.5 to $8.0 million; debt would be issued and used to buy back stock, and the size of the firm would remain constant. The firms analysts have estimated:

1) that the present value of agency cost associated with new debt is 10% of the debt amount used

2) that the present value of any bankruptcy cost is $8 million and that the probability of bankruptcy will increase with leverage according to the following schedule:

Value of debt

in millions

Probability

of default %

2.5 0 5 10 7.5 20 8 22

What is the value of the firm (in millions) for option 1?

Answer for part 1 What is the value of the firm (in millions)for option 2?

Answer for part 2 What is the value of the firm (in millions)for option 3?

Answer for part 3 What is the value of the firm (in millions)for option 4?

Answer for part 4