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At what point do you think the bankruptcy costs will outweigh the interest tax shield? Why?

At what point do you think the bankruptcy costs will outweigh the interest tax shield? Why?

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Answer #1

Companies try to take advantage of raising money through debt. The issue cost is comparatively less than raising capital through equity.The interest on debt also gets the benefit of tax shield. However, if the firm keep raising capital through debt, there comes a point when the interest payable on the debt is 100% adjusted through the profits generated and any additional interest amount doesn't get the benefit of tax shield i.e. tax exhaustive. This is the point at which the bankruptcy costs over-weighs interest tax shield as the firm is in no position to repay its obligations.

References:

https://www.accaglobal.com/in/en/student/exam-support-resources/fundamentals-exams-study-resources/f9/technical-articles/optimum-capital-structure.html

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