Cumulative Effect of Debt and Tax on Firm Value: Optimal Capital Structure Theories in the Light of EMM

We have shown that cornerstone articles considering effects of corporate debt on the firm value and constituting the basis of the trade-off theory of capital structure are wrong.Their main mistake is in ignoring the business securing expenses (BSEs).In the framework of the extended Merton model (EMM), we consider the cumulative effect of debt and corporate taxes on the firm value and its survival, in other words, we revisit Modigliani-Miller Proposition 3 (MMP3).We show that (1) debt affects the firm value and its survival, (2) this effect is negative, diminishing the firm value and its chances to survive, (3) the pressure increases as the debt grows provoking the firm's default, (4) the main factors depressing the levered firm are its debt payments added to the BSEs of the identical unlevered firm and the length of debt maturity, (5) corporate taxes cause development of positive skewness in the asset distribution, but do not affect the location of this distribution in the asset axis.The presented model helps estimate the consequences of choosing this or that level of debt in the presence of corporate taxes and can make a useful instrument for practicing financial managers.