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24 January, 06:56

Which of the following expresses the value of a levered firm (VL) in the Static Tradeoff model of optimal capital structure [Note: VU denotes the value of the unlevered firm; CFD denotes expected costs of financial distress; and PV denotes present value.]

A. VL = PV (Tax Shield) - PV (CFD)

B. VL = VU + PV (Tax Shield) / PV (CFD)

C. VL = VU + PV (Tax Shield) - PV (CFD)

D. VL = VU + PV (Tax Shield)

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Answers (1)
  1. 24 January, 09:17
    0
    C. VL = VU + PV (Tax Shield) - PV (CFD)

    Explanation:

    The static trade off theory is a theory of capital structure in corporate finance, first proposed by Alan Kraus and Robert H. Litzenberger. The theory emphasizes the trade-offs between the tax benefits of increasing leverage and the cost of bankruptcy associated with higher leverage. The answer is C as we know relative to the unleveraged firm, leverage provides both costs and benefits. The benefits are the tax shields provided by debt.
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