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You work for a firm that is very good at sheltering income from corporate taxes
You work for a firm that is very good at sheltering income from corporate taxes. As a result, your firm as a fairly low effective corporate tax rate of 10 percent. The debt holders of your firm face a marginal tax rate on interest income (from debt payments) of 20percent. Your shareholders face a tax rate on capital gains and distributions to equity of 10 percent. In the event of a bankruptcy, your bankruptcy costs will be about 5 percent of the value of the assets that remain. Should you have a lot, a little, or no debt in your capital structure? Explain why.
Expert Solution
I will be trying to place a very low amount of debt capital in my overall capital structure because it is only kept in order to provide a diversification to my overall capital structure because it can be seen that the corporate tax rate is very lower and not be adding to higher amount of benefit in association with interest tax shield so there will be higher cost of debt than the cost of equity as it can be seen that the marginal tax rate for the shareholders are lower than the and debt holders and hence, the company should only have very low proportion of debt capital in order to just diversify its optimal capital structure because 100% funding from equity is not a rational decision.
I WILL BE ADVOCATING FOR A VERY LOW PROPORTION OF DEBT IN OVERALL CAPITAL STRUCTURE JUST FOR THE SAKE OF DIVERSIFICATION OF CAPITAL STRUCTURE.
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