Progressive Home Health Care Inc. is a for-profit provider of home health care services in the Pacific Northwest. At present, it has EBIT of $2 million per year, no debt, and a market value of approximately $12 million. Although management is pleased with the good financial condition of Progressive, they are also concerned that the firm might be the target of a potential hostile takeover by a large competitor. Therefore, Progressive is considering issuing debt to buy back shares, the interest on which would be tax deductible (its tax rate is 40 percent). Management recognizes that as the amount of debt increases, both the value of the firm and the risk of financial distress increase. The CFO estimates that the present value of any future financial distress costs is $8 million, and that the probability of distress increases with the amount of debt in the following steps:

	Probability
	of financial
Value of debt	distress
$0	0%
$2,500,000	1%
$5,000,000	2%
$7,500,000	4%
$10,000,000	8%
$12,500,000	16%
$15,000,000	32%
$20,000,000	64%

(Note: the present value of expected financial distress costs equals the present value of the future financial distress costs times the probability of financial distress.)

Since Progressive currently does not have any debt, the unlevered value of the firm is $12,000,000.

1. what would the value of the firm be if Progressive borrowed $2,500,000? (Hint: Use the Trade-Off Model.)

2. Following the previous questions, what would the value of the firm be if Progressive borrowed $10,000,000? (Hint: Use the Trade-Off Model.)

3. Following the previous questions, what would the value of the firm be if Progressive borrowed $20,000,000? (Hint: Use the Trade-Off Model.)