Suppose that a firm is operating with neutral corporate and personal taxes in an otherwise perfect capital market and Equation (I6.7) currently holds. In such a world, a firm would never take on any risky debt. Why not? (Hint: Consider what would happen in financial distress).
When a firm is operates in an environment with neutral corporate and personal taxes imply that the source of financing has no impact on the tax liability of the firm. Normally, companies usually borrow debt to reduce their tax liability by deducting interest expense. Interest expense is an allowable expense for