Business & Finance Homework Help

According to the managerial entrenchment​ theory, managers choose capital structure so as to preserve their

control of the firm. On the one​ hand, debt is costly for managers because they risk losing control in the event of default. On the other​ hand, if they do not take advantage of the tax shield provided by​ debt, they risk losing control through a hostile takeover. Suppose a firm expects to generate free cash flows of $ 87 million per​ year, and the discount rate for these cash flows is 12 %. The firm pays a tax rate of 35 %. A raider is poised to take over the firm and finance it with $ 620 million in permanent debt. The raider will generate the same free cash​ flows, and the takeover attempt will be successful if the raider can offer a premium of 26 % over the current value of the firm. According to the managerial entrenchment​ hypothesis, what level of permanent debt will the firm​ choose?