The maximum firm value,according to the static theory of capital structure,occurs at a point where the:
A)financial distress costs are equal to zero
B)value of the firm equalises the costs of financial distress with the present value of the tax shield on debt
C)value of a levered firm initially begins to exceed that of an unlevered firm
D)value of the firm is equal to the value defined by M&M Proposition I,with tax
E)value of the firm,as defined by M&M Proposition I,with tax,is exactly equal to the value of the firm,as defined by M&M Proposition I,without tax

Question

Quizplus · Accepted Answer

According to the static theory of capital structure, the maximum value of a firm occurs when the costs of financial distress are equal to the present value of the tax shield on debt. Therefore, option B is the correct choice. Option A is incorrect as it suggests that financial distress costs are equal to zero, which is unlikely in practice. Option C is incorrect as it suggests that the levered firm initially exceeds the unlevered firm, which is not true as the debt financing increases the cost of capital. Option D is incorrect as it mentions M&M Proposition I, which does not deal with the optimal capital structure. Option E is incorrect as the value of the firm with tax is higher than the value of the firm without tax, due to the tax shield on debt.

The Maximum Firm Value,according to the Static Theory of Capital