When corporate taxes and the cost of financial distress are taken into consideration,the market value of a firm equals the value of all-equity financed _____ the PV of the tax shield _____ the PV costs of financial distress.

Question

Quizplus · Accepted Answer

When corporate taxes are taken into consideration, debt financing offers a tax shield benefit to the firm. Hence, the value of all-equity financed plus the present value of the tax shield is a positive term. However, debt financing also increases the probability and cost of financial distress, which has a negative impact on the market value of a firm. Therefore, the present value of costs of financial distress is a negative term. Thus, the market value of a firm equals the value of all-equity financed plus the PV of the tax shield minus the PV costs of financial distress. So, the correct answer is Choice C (Plus; minus).

When Corporate Taxes and the Cost of Financial Distress Are