Iman's Markers produces and sells highlighters and markers of every imaginable color, which are ideal for highlighting course-packs and textbooks. Carolina is CFO of the company and is evaluating the optimal capital structure for the firm. The firm can borrow at 8% and assume that the economic marginal tax rate for the firm is 33.3% regardless of whether it uses debt. If the firm uses too much debt, Carolina knows that it could lead to bankruptcy costs. If bankruptcy actually occurs, bankruptcy costs start at $0.50 per dollar of interest for the first $1000 of interest, are $1.00 per dollar for the second $1000 of interest, $1.50 per dollar for the third $1000 of interest, and incremental costs continue increasing by $0.50 per dollar for each incremental $1000 of interest. Assume that if the firm uses debt of any amount, there is a 10% chance that the firm will go bankrupt. To keep your calculations simple, if Carolina borrows, she will borrow for only one year (she will borrow at and repay the principal and pay interest at ; this means that you cannot use the perpetual formula). What is the optimal amount of debt for this?

Answer rating: 100% (QA)

Heres how to find the optimal amount of debt for Imans Markers 1 Set Up the Framework We need to compare the benefit of using debt tax shield with the ... View the full answer