Assume that the tax rate is 34% and bankruptcy costs are negligible until a firm's debt to equity ratio is greater than one.If Millers Inc.increases debt from 10% of its capital structure to 40%, cash flows to investors will -.

Question

Quizplus · Accepted Answer

By increasing debt from 10% to 40%, Millers Inc. will benefit from the tax shield of debt, which will increase its cash flows to investors. The tax shield is calculated as the tax rate multiplied by the interest expense. Since the tax rate is 34%, and the interest expense will increase with more debt, the tax shield will increase as well, thereby increasing the cash flows to investors. Additionally, since the debt to equity ratio is still below one, there are no bankruptcy costs to consider, so the increase in cash flows is even greater.

Assume That the Tax Rate Is 34% and Bankruptcy Costs