Question 4 Optimal Leverage under Trade-off Theory Your firm currently has no debt and a marginal tax rate of 40%. You are contemplating issuing a one-year bond to pay your shareholders a one-time dividend, but you are unsure how much debt to issue. After one year you will repay the debt However, depending on how much debt you issue you will face a different interest rate and a different probability of financial distress (see table below). If you experience financial distress you expect the present value of distress costs to be $10 million. Assume that there are no agency benefits and no agency costs associated with this transaction. How much debt should you issue? Estimates under Different Debt Levels Debt Principal in $ millions 0 40 60 80 90 4.50% 3.50% 0 4% 5% Probability of Financial Distress 0.0% 0.0% 1.0% 5.0% 9.0%