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

Question

Quizplus · Accepted Answer

The market value of a firm is equal to the value of the all-equity firm plus the present value of the tax shield minus the costs of financial distress. In other words, the tax shield increases the firm's value by reducing its tax liability, while the costs of financial distress decrease the firm's value by adding additional costs associated with potential bankruptcy or default. Therefore, when considering both tax effects and financial distress costs, the market value of the firm is equal to the all-equity value plus the tax shield value minus the costs of financial distress.

When Corporate Taxes and the Cost of Financial Distress Are