Problem $17-10$ Personal Taxes, Bankruptcy Costs, and Firm Value

Overnight Publishing Company $($OPC$)$ has $$2\mathrm{.}5$ million In excess cash. The firm plans to use this cash elther to retire all of Its outstanding debt or to repurchase equity. The firm's debt is held by one institution that is willing to sell It back to OPC for $$2\mathrm{.}5$million. The

Institution will not charge OPC any transaction costs. Once OPC becomes an all$-$equity firm, It will remain unlevered forever. If OPC does not retire the debt, the company will use the $$2\mathrm{.}5$ million in cash to buy back some of its stock on the open market. Repurchasing stock also has no transaction costs. The company will generate $$1\mathrm{.}3$

million of annual earnings before interest and taxes in perpetulty regardless of its capital structure. The firm Immedlately pays out all earnings as dividends at the end of each year. OPC is subject to a corporate tax rate of $21$ percent and the required rate of return

on the firm's unlevered equity is $20$ percent. The personal tax rate on Interest Income is $25$ percent and there are no taxes on equity distribution. Assume there are no bankruptcy costs.

a$.$ What is the value of OPC If it chooses to retire all of its debt and become an unlevered firm? $($Do not round Intermedlate calculations and enter your answer In dollars, not millions of dollars, rounded to the nearest whole number, e$.$g$.,1,234,567.)$

b$.$ What is the value of OPC If it decides to repurchase stock Instead of retiring its debt? $($HInt$.$ Use the equation for the value of a levered firm with personal tax on Interest

Income l$.$e$.,V_L=V_U+\{1-[\frac{1-T_C}{1-T_B}]\}B-C(B))($Do not round Intermedlate calculations and enter your answer In dollars, not millilons of dollars, rounded to the nearest whole number, e$.$g$.,1,234,567.)$

c$.$ What is the value of OPC If the expected bankruptcy costs have a present value of $$400,000?($Do not round Intermedlate calculations and enter your answer in dollars, not millilons of dollars, rounded to the nearest whole number, e$.$g$.,$

$1,234,567.)$