Question

1. What determines the optimal debt level for risky debt? Why do real-world corporations typically not approach this level?

Answer 1

The optimal level of debt is defined as the level of debt which reduces tax liability which is yurn lower the coat of capital of the company. The risky debt should be raised at a level where it doesn't increase the financial risk of the share holders. So debt should be raised where marginal benefits is equal to marginal cost.

In real life corporation tend to be more conservative about this approach, they always maintain a margin of safety. This is because in real life raising funds includes cost which increases the cost of capital. So corporation maintenan a slightly low level of debt as compared to the marginal benefits.