When Both the Tax Deductibility of Debt and the Present

question 31

Multiple Choice

When both the tax deductibility of debt and the present value of potential bankruptcy costs are included,the cost of capital for a firm tends to:

• A) be constant regardless of the level of debt usage.
• B) decrease as the level of debt increases.
• C) increase as the level of debt increases.
• D) decrease up to some debt-value ratio,then increase as bankruptcy costs become significant.

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Definitions:

Pure Monopsony

A market condition where there is only one buyer for a product or service, giving that buyer significant control over market conditions.

Injunction

A legal order issued by a court that compels a party to do or refrain from specific acts.

National Labor Relations Act

A 1935 U.S. law that protects the rights of employees and employers, encourages collective bargaining, and curtails certain private sector labor and management practices.

Closed Shop

An agreement where a company agrees to hire union members only, and employees must remain members of the union at all times.