Explain why there are costs of financial distress. Identify these costs. Consider both bankruptcy-related costs and potential costs relating to the conflict of interests between equity and debt. Describe these costs, and explain how they will impact on company value.

 

b) Briefly explain the static trade-off theory of capital structure and the pecking order theory of capital structure. Describe how each theory identifies factors that will influence what is optimal capital structure.

c) Explain why Cost of Capital estimates must be adjusted to make allowance for company taxes. Describe how this can impact on optimal capital structure. Also, consider if personal taxes are important. Include a description and explanation of the relative advantage formula. 

d) Anticipated costs of financial distress probably will impact on cost of capital, if borrowing becomes excessive. Identify these types of cost, explain how they are incurred, and discuss how they will impact on company value. Contrast the potential payoffs to bondholders and shareholders in circumstances of limited and unlimited liability.