Supposed the firm is in financial distress since, based on the current asset value is only 8 million, 1 while the outstanding debt is 10 million.

Firm's manager comes up with a new proposal for a new project that doesn't require any upfront investment.

This project is although risky as there is only 30% probability that the project will be successful.

If this project is successful, the payoff will be 13 million, but if it fails, the payoff will be only 6 million

Let's calculate the total value of the firm in two scenarios:

1. No financial distress cost if firm goes bankrupt

2. There is 3 million financial distress cost if firm goes bankrupt.

Assume equity cost of capital is equal debt's risk free rate at 5%