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Discuss why using debt financing is argued to be increasing firm value and why the optimum...

Discuss why using debt financing is argued to be increasing firm value and why the optimum capital structure is not 100% debt financing.    

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Answer #1

Since interests are tax deductible hence debt financing increases value . The Value of Levered firm = Value of Unlevered Firm + Debt* Tax Rate. Moreover cost of debt is less than cost of equity because debt holders have first right in case of liquidation.

100% debt financing increases the risk of the firm and hence the incremental cost of debt increases and in case of recession the debt repaying capacity of the firm decreases which might create default of payment.

Please Discuss in case of Doubt

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