In Miller's model, when the quantity [(1-Tc)(1-Ts) = (1-Tb)], then:
A)the ﬁrm should hold no debt.
B)the value of the levered ﬁrm is greater than the value of the unlevered ﬁrm.
C)the tax shield on debt is exactly offset by higher personal taxes paid on interest income.
D)the tax shield on debt is exactly offset by higher levels of dividends.
E)the tax shield on debt is exactly offset by higher capital gains.

Question

Quizplus · Accepted Answer

When the quantity [(1-Tc)(1-Ts) = (1-Tb)] is true, it means that the tax shield on debt is exactly offset by higher personal taxes paid on interest income. In other words, the benefit of the tax shield from debt is cancelled out by the higher taxes paid on the interest income received by the shareholders. Therefore, the value of the levered firm is not greater than the value of the unlevered firm, as in option B. The other options are also incorrect.

In Miller's Model, When the Quantity [(1-Tc)(1-Ts) = (1-Tb)], Then