Firm A is thinking about issuing 1 year debt. Your finance department has the following estimates of the value of the interest tax shield and the probability of financial distress for different levels of debt:

If the firm is in financial distress, Firm A will have a distressing cost of 100 M in PV. Which level of debt is optimal give the table above? Why?

Debt Level in Million $ 0 50 100 150 200 0 10 M PV (int tax shield) Probability of financial distress 20 M 5% 30 M 8% 40M 15% 0% 30%