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We argue that risk premia affect the valuation of financial distress costs, because these costs are more likely to be incurred in bad times. We compute the NPV of distress costs using risk-adjusted default probabilities that are derived from corporate bond spreads. Because credit spreads are large, the magnitude of the risk-adjustment is substantial. For a firm whose bonds are rated BBB, our benchmark calculations show that the risk-adjusted NPV of distress is 4.5% of pre-distress firm value.doi:10.3386/w11685 fatcat:2uufcen6zndktg7ce6k62uy3da