Question

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 V_L + T_C ×D.

Value of the levered firm will exceed the value of the firm if it were unlevered.

Debt-equity ratio is equal to 1.

Answer 1

Solution:- The correct statement is

Ans:- Value of the levered firm will exceed the value of the firm if it were unlevered.

Reason:- When the entty is optmially levered means, theres is the appropriate amount to debt in the companyas compared to . Whern there optimal amount of debt , the firm value increased due to tax saving in interest and lower cost of debt. When there is lower cost of debt and tax saving on interest, the earning atributable to equity holder increases which in turn increases the vaule of firm.