Assuming the interest on the debt is fully tax deductible,when firms issue more debt,the present value of the tax shield on debt ________ while the present value of the financial distress costs ________.
A)decreases; decreases
B)increases; increases
C)decreases; remains constant
D)decreases; increases
E)increases; remains constant

Question

Quizplus · Accepted Answer

When firms issue more debt, the present value of the tax shield on debt increases because the interest payments on the debt are tax-deductible, leading to tax savings. At the same time, the present value of financial distress costs also increases because higher levels of debt increase the risk of financial distress.

Assuming the Interest on the Debt Is Fully Tax Deductible,when