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

Overnight Publishing Company $($OPC$)$ has $$3\mathrm{.}2$ million in excess cash. The firm plans to

use this cash either 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 $$3\mathrm{.}2$ 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 $$3\mathrm{.}2$ 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

$$1,370,000$ of annual earnings before interest and taxes in perpetuity regardless of its

capital structure. The firm immediately pays out all earnings as dividends at the end of

each year. OPC is subject to a corporate tax rate of $22$ percent and the required rate of

return on the firm's unlevered equity is $12$ percent. The personal tax rate on interest

income is $15$ percent and there are no taxes on equity distributions. 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 intermediate 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 from Problem $9$ in the textbook.$)($Do not round intermediate calculations

and enter your answer in dollars, not millions 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

$$650,000?($Do not round intermediate calculations and enter your answers in

dollars, not millions of dollars, rounded to the nearest whole number, e$.$g$.,$

$1,234,567.)$

c$.$ Levered value