In the Kohwe Corporation leverage financing scenario (borrowing $49.4 million, corporate tax rate 20%, discount rate 8.4%), what is Kohwe’s share price today if financial distress reduces free cash flow from $10.7 million to $9.7 million per year?

What you are valuing in this leverage problem

You are trying to find the value per share (equity value divided by shares). With perpetual (level forever) free cash flows and a permanent, interest-only debt balance, the clean way to do this is to value the operating cash flows as a perpetuity and then add the value effect of interest tax shields.

Step 1: Value the business cash flows after distress

The financial distress effect is already built into the lower free cash flow: $\text{FCF} = 9.7$ million per year.

Because the discount rate for Kohwe’s future free cash flows is $r = 8.4\%$, the present value of a perpetuity is:

$$V_{\text{assets}} = \frac{\text{FCF}}{r} = \frac{9.7}{0.084} = 115.476\text{ million}$$

Step 2: Add the present value of the interest tax shield

With permanent debt (the firm maintains an outstanding balance of $D = 49.4$ million), the standard result is:

$$PV(\text{tax shield}) = T_c \times D$$

So:

$$PV(\text{tax shield}) = 0.20 \times 49.4 = 9.88\text{ million}$$

Step 3: Convert total firm value to equity value, then to price per share

Total levered firm value:

$$V_L = V_{\text{assets}} + PV(\text{tax shield}) = 115.476 + 9.88 = 125.356\text{ million}$$

Equity value is firm value minus debt:

$$E = V_L - D = 125.356 - 49.4 = 75.956\text{ million}$$

Price per share with 4.7 million shares:

$$P_0 = \frac{E}{\text{shares}} = \frac{75.956}{4.7} = 16.161 \approx \$16.16$$

Quick reasonableness check

Because distress lowers annual FCF by $1.0$ million forever, it reduces value by about $1.0/0.084 \approx 11.9$ million, which is larger than the $9.88$ million tax-shield benefit. So the share price should be lower than it would be without distress, and it is.