For instance the value of a real estate company can

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Unformatted text preview: ween debt and shareholders in bankruptcy, since shareholders are the residual claimants. Moreover, cost of financial distress varies with the type of the asset, as some assets are transferable whereas others are non-transferable. For instance, the value of a real estate company can easily be auctioned off, whereas it is significantly more involved to transfer the value of a biotech company where value is related to human capital. Download free ebooks at 63 Corporate Finance Corporate financing and valuation The cost of financial distress will increase with financial leverage as the expected cost of financial distress is the probability of financial distress times the actual cost of financial distress. As more debt will increase the likelihood of bankrupt, it follows that the expected cost of financial distress will be increasing in the debt ratio. In summary, introducing corporate taxes and cost of financial distress provides a benefit and a cost of financial leverage. The trade-off theory conjectures that the optimal capital structure is a trade-off between interest ta...
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