In Miller's model, when the quantity (1 − T_C)(1 − T_p_E)= (1 − T_p), then A)the firm should hold no debt. B)the value of the levered firm is greater than the value of the unlevered firm. C)the tax shield on debt is exactly offset by higher personal taxes paid on interest income. D)the firm should be financed by 100 percent equity.

Question

Quizplus · Accepted Answer

When the equation (1 − T_C)(1 − T_p_E)= (1 − T_p) holds, it means that the tax shield on debt is exactly offset by higher personal taxes paid on interest income. In such a case, it doesn't make sense for the firm to have any debt. Therefore, the firm should hold no debt (A) and should be financed by 100% equity (D). However, the value of the levered firm is not greater than the value of the unlevered firm (B) as the firm would lose the tax shield benefits by not using debt in its capital structure.

In Miller's Model, When the Quantity (1 − TC)(1 −

In Miller's Model, When the Quantity (1 − T_C)(1 −