When bankruptcy is added to the M&M world of capital structure,which of the following statements is TRUE as more debt is added to the financing mix of the company?
A)The interest tax shield is a benefit to equity holders,although they bear increasing risk.
B)The advantage of the tax shield starts to be offset by financial distress costs.
C)The WACC of the company starts to increase past a certain level of debt.
D)All of the above

Question

Quizplus · Accepted Answer

All the statements are true when considering the effects of bankruptcy in the Modigliani-Miller framework on capital structure. As more debt is added, the interest tax shield benefits equity holders but also increases their risk, the benefits of the tax shield are offset by financial distress costs, and the company's WACC begins to increase past a certain level of debt due to these distress costs and increased risk.

When Bankruptcy Is Added to the M&M World of Capital