CFA Level I · CFA Level I Exam · Capital Structure
A firm has a marginal tax rate of 30% and permanent debt of 200 million. Its value if unlevered is 900 million. The present value of expected financial distress costs at this debt level is 25 million. Using the static trade-off framework, the value of the levered firm is closest to:
The levered firm value is about 935 million. The tax shield on permanent debt is 30% × 200 = 60 million. Adding it to unlevered value of 900 million gives 960 million, and subtracting 25 million of distress costs gives 935 million.
- A935 millionCorrect
- B960 million
- C1,100 million
Explanation
Tax shield PV = 0.30 × 200 = 60 million. Levered value = 900 + 60 − 25 = 935 million. The 960 million option omits distress costs; 1,100 million wrongly adds the debt itself.
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