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bankruptcy code? Chapter 7 bankruptcy- Absolute priority? Chapter 11 bankruptcy- Debtholders and equityholders get new claims instead of the old ones- Reorganization plan
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9Costs of bankruptcy? Direct costs- Management time- Legal expenses and advisors' fees- Court costs? Indirect costs- Conflicts of interests between equityholders and debtholders (agency problems)
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10Trade-off between tax shield and cost of financial distressValue of the firm =Value of all equity financed+ PV tax shield- PV costs of financial distressOptimalDebt RatioValue if all equity financedPV of costs of financial distressPV Tax ShieldsDebt RatioMarket Value
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11Bankruptcy Costs? Jerry Warner examined bankruptcies of 11 railroads to estimate the costs of bankruptcy? The bankruptcy proceedings typical lasted many years...
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