Your firm is considering issuing one-year debt and has come up with the following estimates of the value of the interest tax shield and the probability of distress for different levels of debt: PV (interest tax shield, in $ million) Probability of Financial Distress 0 $80 million $90 million $50 million $2 million 0.01 0.00% 10 0.70 0.00% Debt Level (in $ million) 30 50 70 0.90 1.00% 1.15 2.00% 1.30 7.00% 90 1.50 16.00% 110 1.70 31.00% Suppose the firm has a beta of zero, so that the appropriate discount rate for financial distress costs is the risk-free rate of 5%. Which level of debt above is optimal if, in the event of distress, the firm will have distress costs equal to $2 million?
Your firm is considering issuing one-year debt and has come up with the following estimates of the value of the interest tax shield and the probability of distress for different levels of debt: PV (interest tax shield, in $ million) Probability of Financial Distress 0 $80 million $90 million $50 million $2 million 0.01 0.00% 10 0.70 0.00% Debt Level (in $ million) 30 50 70 0.90 1.00% 1.15 2.00% 1.30 7.00% 90 1.50 16.00% 110 1.70 31.00% Suppose the firm has a beta of zero, so that the appropriate discount rate for financial distress costs is the risk-free rate of 5%. Which level of debt above is optimal if, in the event of distress, the firm will have distress costs equal to $2 million?
Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter11: Determining The Cost Of Capital
Section: Chapter Questions
Problem 14P
Related questions
Question
![Your firm is considering issuing one-year debt and has come up with the following
estimates of the value of the interest tax shield and the probability of distress for
different levels of debt:
PV (interest tax shield, in $ million)
0
$80 million
$90 million
$50 million
$2 million
0.01
0.00%
10
0.70
0.00%
Debt Level (in $ million)
30
50
0.90
1.00%
1.15
2.00%
70
1.30
7.00%
90
1.50
16.00%
110
1.70
Probability of Financial Distress
Suppose the firm has a beta of zero, so that the appropriate discount rate for
financial distress costs is the risk-free rate of 5%. Which level of debt above is
optimal if, in the event of distress, the firm will have distress costs equal to $2
million?
31.00%](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2Fc2e99bea-40b4-4871-b1c7-d768a8898c09%2F3c711087-cab6-4793-9008-c5379b115c9f%2Fiktnfj_processed.png&w=3840&q=75)
Transcribed Image Text:Your firm is considering issuing one-year debt and has come up with the following
estimates of the value of the interest tax shield and the probability of distress for
different levels of debt:
PV (interest tax shield, in $ million)
0
$80 million
$90 million
$50 million
$2 million
0.01
0.00%
10
0.70
0.00%
Debt Level (in $ million)
30
50
0.90
1.00%
1.15
2.00%
70
1.30
7.00%
90
1.50
16.00%
110
1.70
Probability of Financial Distress
Suppose the firm has a beta of zero, so that the appropriate discount rate for
financial distress costs is the risk-free rate of 5%. Which level of debt above is
optimal if, in the event of distress, the firm will have distress costs equal to $2
million?
31.00%
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