Managers replacing some stockholders with creditors

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Reference no: EM13917461

A firm with a 40% marginal tax rate pays $1000 in interest on bonds that have a 6% yield-to-maturity. Assuming the bonds will never be paid-off, the market value of the tax savings is:

40($1000)/.06 = $6,666.67

Market value of debt = $1000/.06 = $16,666.67

40% of this value comes from reduced taxes

Accepting the first proposition means there is not an agency problem arising from managers replacing some stockholders with creditors. Why is there no agency problem?

Reference no: EM13917461

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