Pony Corp wants to issue debt with one year maturity. Adding debt will increase the cost...

 

 

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Pony Corp wants to issue debt with one year maturity. Adding debt will increase the cost of bankruptcy, but also increase the tax benefit of debt. Pony has calculated the following estimates of the value of the present value of the interest tax shield PV(TS) and the probability of bankruptcy for different levels of debt. In the event of distress the firm will suffer total bankruptcy costs equal to $50 million Which level of debt above is optimal? Face Value of Debt $0 mill $20 mill $ 30 mill $40 mill $50 mill $60 mill $70 mill PV of Tax Shield $0 mill $5 mill $7.5 mill $10 mill $12.5 mill $15 mill $17.5 mill Probability of Bankruptcy 0 2.5% 4% 6% 15% 35% 40% Pony Corp wants to issue debt with one year maturity. Adding debt will increase the cost of bankruptcy, but also increase the tax benefit of debt. Pony has calculated the following estimates of the value of the present value of the interest tax shield PV(TS) and the probability of bankruptcy for different levels of debt. In the event of distress the firm will suffer total bankruptcy costs equal to $50 million Which level of debt above is optimal? Face Value of Debt $0 mill $20 mill $ 30 mill $40 mill $50 mill $60 mill $70 mill PV of Tax Shield $0 mill $5 mill $7.5 mill $10 mill $12.5 mill $15 mill $17.5 mill Probability of Bankruptcy 0 2.5% 4% 6% 15% 35% 40%

Answer rating: 100% (QA)

The optimal level of debt for Pony Corp is 30 million Heres why Tradeoff Analysis We need to weigh t... View the full answer