21 Theypresenttwowaysofadjustingdistresscostvalueto
reflect this systematic risk. In the first, they derive
probabilitiesofdefaultfromcorporatebondspreads,akinto
whatwedidearlierinIllustration17.1.Inthesecond,they
derive the risk adjustmentfrom historicaldata on distress
probabilitiesandassetpricingmodels.Theyconcludethatthe
expectedbankruptcy costsaresubstantial and havea large
impact on value.
ILLUSTRATION17.4: ValuingGlobal Crossing:Adjusted
Present Value
TovalueGlobalCrossingonanadjustedpresentvaluebasis,
wewouldfirstneedtovaluethefirmasanunleveredentity.
Wecandothisbyusingtheunleveredcostofequityasthe
cost of capital.
Unlevered beta for Global Crossing
22 = 0.7527
Usingtherisk-freerateof4.8%andthemarketriskpremium
of 4%,
Weusethiscostofequityasthecostofcapitalanddiscount
the expectedfree cash flows to the firmshown earlierin
Illustration17.3.Thefollowingtablesummarizesthepresent
valueofthecash flowsattheunleveredcost ofequity(in
millions of dollars). (Note that the terminal value is left
unchanged.Wewillcontinuetoassumethatthefirmwillearn
its cost of capital on investments after year 10.)