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A company plans to issue debt with a maturity of one year and has made the following estimates of the debt-related tax benefit and the
A company plans to issue debt with a maturity of one year and has made the following estimates of the debt-related tax benefit and the probability of financial distress with debt in varying amounts.
The discount rate is 5% because all market participants are risk neutral. What level of debt is optimal if the company incurs the following costs in the event of financial distress
(a) EUR 3 million?
(b) EUR 5 million?
(c) EUR 25 million?
\begin{tabular}{l|c|c|c|c|c|c} \hline & \multicolumn{5}{|c}{ Borraved capital (in millian) } \\ \hline & 0 & 40 & 50 & 60 & 70 & 80 \\ \hline leveragedtaxberefitsinmilliag & 0 & 0.76 & 0.95 & 1.14 & 1.33 & 1.52 \\ \hline probabilityoffinancialdistressin% & 0% & 0% & 1% & 2% & 7% & 16% \\ \hline \end{tabular} \begin{tabular}{l|c|c|c|c|c|c} \hline & \multicolumn{5}{|c}{ Borraved capital (in millian) } \\ \hline & 0 & 40 & 50 & 60 & 70 & 80 \\ \hline leveragedtaxberefitsinmilliag & 0 & 0.76 & 0.95 & 1.14 & 1.33 & 1.52 \\ \hline probabilityoffinancialdistressin% & 0% & 0% & 1% & 2% & 7% & 16% \\ \hline \end{tabular}Step by Step Solution
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