The interest tax shield is a key reason why
A)the value of an unlevered firm is equal to the value of a levered firm.
B)the net cost of debt to a firm is generally less than the cost of equity.
C)firms tend to minimize their borrowing.
D)the cost of debt is equal to the cost of equity for a firm with a debt-to-equity ratio of 1.
E)firms prefer equity financing over debt financing.

Question

Quizplus · Accepted Answer

The interest tax shield is the deduction from taxable income due to interest payments, resulting in a lower tax bill. This benefit reduces the overall cost of debt to a firm and makes it cheaper than equity financing. Thus, the net cost of debt to a firm is generally less than the cost of equity. This is why firms tend to use debt financing to take advantage of the interest tax shield and increase their value. However, maximizing the use of debt financing can also increase financial risk.

The Interest Tax Shield Is a Key Reason Why