DEBT AND TAXES

IN A WORLD IN WHICH INTEREST PAYMENTS ARE FULLY DEDUCTIBLE IN COMPUTING CORPORATE INCOME TAXES, THE VALUE OF THE FIRM, IN EQUILIBRIUM, WILL STILL BE INDEPENDENT OF ITS CAPITAL STRUCTURE. THE GREAT EMPHASIS ON BANKRUPTCY COSTS IN RECENT DISCUSSIONS SEEMS TO HAVE BEEN MISPLACED. ANY SITUATION IN WHICH THE OWNERS OF CORPORATIONS COULD INCREASE THEIR WEALTH BY SUBSTITUTING DEBT FOR EQUITY, OR VICE VERSA, WOULD BE INCOMPATIBLE WITH MARKET EQUILIBRIUM. THEIR ATTEMPTS TO EXPLOIT THESE OPPORTUNITIES CHANGES THE YIELDS ON STOCKS AND BONDS, THUS RESTORING EQUILIBRIUM AND REMOVING INCENTIVES TO ISSUE MORE DEBT EVEN WITHOUT INVOKING BANKRUPTCY COSTS OR LENDING COSTS. GRAPH. REFERENCES.