CHAPTER_18_updated2 - CHAPTER 18 Question 23 Corrected...

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1 CHAPTER 18 Question 23 Corrected 3-2-11 How Much Should a Corporation Borrow? Answers to Problem Sets 2. a. PV tax shield = T c D = $16. b. T c X 20 = $8. 3. Relative advantage of debt = () () c pE p T T T 1 1 1 = () ( ) 00 . 1 65 . 1 65 . = Relative advantage = () () 18 . 1 65 . 85 . 65 . = 9. When a company issues securities, outside investors worry that management may have unfavorable information. If so the securities can be overpriced. This worry is much less with debt than equity. Debt securities are safer than equity, and their price is less affected if unfavorable news comes out later. A company that can borrow (without incurring substantial costs of financial distress) usually does so. An issue of equity would be read as “bad news” by investors, and the new stock could be sold only at a discount to the previous market price. 10.
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CHAPTER_18_updated2 - CHAPTER 18 Question 23 Corrected...

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