Identify the costs of financial distress

Reference no: EM132200297

Question -

a) Describe the basic Modigliani and Miller proposition regarding capital structure. Explain why this proposition must be adjusted, when allowance is made for company taxes. How does this impact on optimal capital structure? Consider whether personal taxes may also be important. Conclude with a description of the relative advantage formula.

b) Assuming that the company tax rate (T_c) is thirty-five percent, that the personal tax rate on equity income (T_pE) is thirty percent, and that the personal tax rate on interest income (T_p) is twenty percent, estimate the relative tax advantage of debt. Briefly consider whether the relative advantage formula can be successfully applied to large numbers of companies and investors.

c) Identify the costs of financial distress. Consider both bankruptcy related costs and the costs associated with distorted decision-taking. Describe how these costs are incurred, and explain how they will impact on company value. Use examples that will demonstrate your points.

Reference no: EM132200297

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