In a world with corporate taxes and no bankruptcy costs,

Question

Quizplus · Accepted Answer

In a world with corporate taxes and no bankruptcy costs, leverage can affect the firm value by an amount that is equal to the present value of the interest tax shield. This is because by using debt, the interest payments are tax-deductible, leading to a lower tax bill and an increase in the firm's value. However, if bankruptcy costs were present, the optimal level of debt that maximizes the firm value would be lower than the maximum debt level without bankruptcy costs. Therefore, option C is not correct. Option B is partially correct, as leverage does lower the taxes of the firm, but it is not necessarily true that it always increases the firm's total value.

In a World with Corporate Taxes and No Bankruptcy Costs