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Your firm is considering issuing one-year debt, and has come up with the following estimates...

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Your firm is considering issuing one-year debt, and has come up with the following 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? 40 Debt Level (in $ million) 50 60 70 0.95 1.14 1.33 1% 2% 7% 0 0.00 0% PV (interest tax shield, S million) Probability of Financial Distress 0.76 0% 80 1.52 16% 90 1.71 31%

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