Which of the following expresses the value of a levered firm (vl) in the static tradeoff model of optimal capital structure [note: vu denotes the value of the unlevered firm; cfd denotes expected costs of financial distress; and pv denotes present value.]

a. vl = pv(tax shield) - pv(cfd)

b. vl = vu + pv(tax shield) / pv(cfd)

c. vl = vu + pv(tax shield) - pv(cfd)

d. vl = vu + pv(tax shield)

C. VL = VU + PV(Tax Shield) - PV(CFD)

Explanation:

The static trade off theory is a theory of capital structure in corporate finance, first proposed by Alan Kraus and Robert H. Litzenberger. The theory emphasizes the trade-offs between the tax benefits of increasing leverage and the cost of bankruptcy associated with higher leverage. The answer is C as we know relative to the unleveraged firm, leverage provides both costs and benefits. The benefits are the tax shields provided by debt.

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