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

Question

Quizplus · Accepted Answer

When a firm is all-equity financed, there is no tax shield since there is no interest to be deducted from taxable income. Therefore, the value with all-equity financing is subtracted from the value including the PV of the tax shield. However, the cost of financial distress is a negative factor that decreases the overall value, so it is subtracted as well. Therefore, the market value of a firm equals the value if all-equity financed plus the PV of the tax shield minus the costs of financial distress.

When Corporate Taxes and the Cost of Financial Distress Are