L3: Taxes and Financial Distress Flashcards
What is missing from the MM view?
In a semi-perfect world, where we have taxes, do companies have an incentive to increase or decrease their leverage rations?
MM with taxes
Example:Debt tax shield
Leveraged recapitalization
Process of using proceeds of debt issuance to buy back some of its own shares
CF going to capital holders with taxes
Value levered firm with taxes
Special Case - Perpetual debt
From a pure tax saving perspective:
- What is the optimal leverage for the firm?
- What if the firm just raises debt and sits on the money, investing it in risk free securities?
Why do firms not change their leverage ratio to 100%?
Effects of personal taxes: Taxing of debt and equity
Effects of personal taxes: Taxing of debt and equity CONCLUSION
Effects of personal taxes: extreme cases
Effects of taxes if securities are held by insitutions that don’t pay personal taxes (e.g., mutual funds, pension funds, endowments)
Bankruptcy cost / CoFD