25557 Chapter Notes - Chapter 18: Tax Shield, Financial Distress, Root Mean Square
Document Summary
With the tax shield bene t, rm value and shareholders wealth continues to increase as debt increases; the optimal debt policy appears to be 100% debt nanced. However, there are many rms that thrive with little debt at all; perhaps there is a tax advantage of corporate borrowing still to be uncovered and perhaps rms that borrow would incur other costs. Apart from borrowing, rms can claim accelerated depreciation and many other education to shield income against tax. If a rm cannot earn enough income to cover the interest payment, the tax shield cannot be utilised immediately and the rm loses the time value of money while it waits. For rms that are unlikely to earn suf cient pro ts to bene t from the corporate tax shield there is little net tax advantage to borrowing. Occurs when promises to creditors are broken or honoured with dif culty, sometimes leading to bankruptcy.
