Which one of these statements is correct for a levered firm?
A)An increase in tax rates will decrease the value of the firm.
B)An increase in financial distress costs increases the value of a firm.
C)To obtain its maximum value,a firm should select an all-equity capital structure.
D)The value of a firm is maximized when its cost of capital is also maximized.
E)The optimal level of debt for a firm results in the value of that firm being maximized.

Question

Quizplus · Accepted Answer

The optimal level of debt for a levered firm results in the value of that firm being maximized. This is because as debt increases, the cost of capital decreases due to the tax shield provided by interest payments. However, if the firm takes on too much debt, it may face financial distress costs that negate the benefits of the tax shield, leading to a decrease in firm value. Therefore, the optimal level of debt is the balance between the tax shield benefit and financial distress costs. Choices A, B, C, and D are all incorrect as they do not accurately describe the relationship between leverage and firm value.

Which One of These Statements Is Correct for a Levered