Your firm is considering issuing one-year debt, and has come up with the following table of estimates of the value of the interest tax shield and the probability of distress for different levels of debt. Suppose the firm has a beta of zero, so that the appropriate discount rate for financial distress costs is the risk-free rate of 5%. Which level of debt above is optimal if, in the event of distress, the firm will have distress costs equal to: a. $2 million? b. $5 million? c. $25 million?

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Debt Levels (in $ million) PV (interest tax shield, $ million Probability of Financial Distress 0 0 0% 40 0.76 0% 50 0.95 196 60 1.14 2% 70 1.33 7% 80 1.52 16% 90 1.71 31%