Question

If the present value of the tax shield equals the present value
of the costs of financial distress, then the:

A. Firm should increase its use of debt.

B. Firm is using the optimal level of debt.

C. Firm is paying too high an interest rate.

D. Firm’s market value equals the value of the unlevered firm.

.

Answer #1

**Key Points:**

- The trade-off theory of capital structure is the idea that a company chooses how much debt finance and how much equity finance to use by balancing the costs and benefits.
- The trade-off theory states that the optimal capital structure is a trade-off between interest tax shields and cost of financial distress

So, Option **B) Firm is using
the optimal level of debt is correct**

?**Thank you, please give an
upvote** ?

Calculate the annual value of an interest tax shield under the
assumption that a firm maintains debt at a permanent $1,000,000
level and rate of 12 percent. The corporate tax rate is 35 percent.
If there is no chance of financial distress, how does the value of
the firm change as a result of this debt?

Which of the following statements is false
if capital markets have both taxes and financial distress as the
market imperfections?
A.
If two firms are identical but differ only in their capital
structure, then the value of the levered firm is higher than the
value of the unlevered firm by the present value of the interest
tax shield
B.
There is an optimal capital structure that can maximize firm
value
C.
The capital structure choice considers a trade-off between the
tax...

If a firm has the optimal amount of debt, then the:
Which one is correct?
Direct financial distress costs
must equal the present value of the interest tax shield.
Value of the firm is
minimized.
Value of the firm is equal to
VL + TC ×D.
Value of the levered firm will
exceed the value of the firm if it were unlevered.
Debt-equity ratio is equal to
1.

Which of the following expresses the value of a levered firm
(VL) in the Static Tradeoff model of optimal capital structure?
[Note: VU denotes the value of the unlevered firm; CFD denotes
expected costs of financial distress; and PV denotes present
value.]
A. VL = PV(Tax Shield) - PV(CFD)
B. VL = VU + PV(Tax Shield) / PV(CFD)
C. VL = VU + PV(Tax Shield) - PV(CFD)
D. VL = VU + PV(Tax Shield)

Suppose the portfolio of a large institutional investor
“Parthenon” has an expected return of 13 percent and its beta
relative to the market portfolio is 2, while its return’s standard
deviation is 8 percent. Suppose there is a firm called “Atlantis”,
whose equity beta is 2. The equity value of “Atlantis” is £1
million and its debt is worth £1.5 million. Its debt is a consol
bond (i.e. perpetual bond) with an annual coupon of £45,000. The
present value of...

Trojan Ltd is an all-equity firm subject to a 30 percent tax
rate. Its total market value
is initially $3,500,000. There are 175,000 shares outstanding. The
firm announces a
program to issue $1 million worth of bonds at 10 percent interest
and to use the
proceeds to buy back common stock. Assume that there is no change
in costs of
financial distress and that the debt is perpetual.
Required:
a. What is the value of the tax shield that Trojan...

If we extend the MM's framework by corporate taxes (but no
distress costs) then
a) Equity becomes more attractive because it is subject to
corporate tax and we can take advantage of the tax shield
b) Interest payments on debt are tax deductible which increases
the Weighted average cost of capital for high levels of debt
relative to the standard MM framework
c) The present value of future tax savings increases the market
value of the firm
d) More than...

ACCM Inc. is considering adding leverage to its capital
structure. The firm’s managers believe they can issue more debt to
exploit the tax benefit of leverage. However, they also recognize
that higher debt increases the risk of financial distress. Based on
simulation of the firm’s future cash flows, the managers have made
the following estimates (in millions of dollars) for different
levels of debt (%) in the firm capital structure.
Debt level
10%
20%
30%
40%
50%
PV(Interest tax shield)...

ACCM Inc. is considering adding leverage to its capital
structure. The firm’s managers believe they can issue more debt to
exploit the tax benefit of leverage. However, they also recognize
that higher debt increases the risk of financial distress. Based on
simulation of the firm’s future cash flows, the managers have made
the following estimates (in millions of dollars) for different
levels of debt (%) in the firm capital structure.
Debt level
10%
20%
30%
40%
50%
PV(Interest tax shield)...

XYZ is a no-growth firm and its current unlevered value is
VU=$800,000, and its marginal corporate tax rate is 35%. Also, you
model the Firm's PV of financial distress as a function of its debt
ratio (D/VU) according to the relation:PV of financial
distress=800,000 x (D/V)^2. The optimal percentage of perpetual
debt (D) to the levered firm value (i.e. D/VL, the effective
debt/value-ratio), given debt proceeds are used to buy back stock,
is closest to: a) 0.25 b) 0.6 c)...

ADVERTISEMENT

Get Answers For Free

Most questions answered within 1 hours.

ADVERTISEMENT

asked 1 minute ago

asked 20 minutes ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 1 hour ago

asked 2 hours ago

asked 2 hours ago

asked 3 hours ago

asked 3 hours ago

asked 3 hours ago

asked 3 hours ago