When financial distress is a possibility, the value of a levered firm is a function of:
I.value of the firm if all-equity-financed;
II.present value of tax shield;
III.present value of costs of financial distress;
IV.present value of omitted dividend payments
A)I only
B)I + II
C)I + II − III
D)I + II - III − IV

Question

Quizplus · Accepted Answer

The value of a levered firm is indeed a function of the value of the firm if it were all-equity-financed (I), the present value of the tax shield (II), and the present value of costs of financial distress (III). The value of a levered firm is increased by the tax shield on debt and decreased by the costs of financial distress. Omitted dividend payments (IV) are not typically considered in this valuation framework.

When Financial Distress Is a Possibility, the Value of a Levered