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

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?

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