1. Overall Mkt. Value = Value if all Equity Financed + PV Tax Shield
Costs of Financial Distress: Costs arising from bankruptcy or distorted business decisions before bankruptcy
Overall Mkt. Value = Value if all Equity Financed
+ PV Tax Shield
- PV Costs of Financial Distress
LO3
© 2012 McGraw-Hill Ryerson Limited

2. 16.3 Costs of Financial Distress
Bankruptcy Costs: The fees involved in a bankruptcy proceeding are paid out of the remaining value of the firm’s assets. If there is a possibility of bankruptcy, the current market value of the firm is reduced by the present value of these potential costs.
Indirect Costs of bankruptcy: difficulty of running a company while it is going through bankruptcy
Financial distress without bankruptcy: Firms may incur substantial costs even if they can postpone bankruptcy. Thus financial distress costs will be there
LO3
© 2012 McGraw-Hill Ryerson Limited

3. 16.3 Costs of Financial Distress
The First Game: Bet the Bank’s Money
The Second Game: Don’t bet your Own Money
Costs of Distress Vary with Type of Asset
LO3
© 2012 McGraw-Hill Ryerson Limited