Capital Structure and Firm Value

a. Show graphically (in Debt-Value space) how firm value is affected by debt when i) there are no corporate taxes, corporate debt is riskless and there are no bankruptcy costs, ii) there are corporate taxes, but corporate debt is riskless and there are no bankruptcy costs, and iii) there are corporate taxes, but corporate debt is risky and there are bankruptcy costs.

b. From a, what do each of these three scenarios imply about optimal capital structure? Which scenario do you think is more realistic?

c. Explain how the firm investing and financing decisions are separate and, if there is an optimal capital structure, how will this affect how new projects (investments) are financed?