If the interest rate on debt is rD, what adjusted discount rate should the company use when valuing financial leases? The marginal tax rate is Tc.

Question

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When valuing financial leases, the company should adjust the discount rate by taking into account the tax benefits of debt financing. The adjusted discount rate should be equal to the interest rate on debt multiplied by one minus the marginal tax rate (rD(1-Tc)). This is because the tax benefits of debt reduce the effective cost of borrowing, resulting in a lower discount rate for financial lease valuation. Choice A is therefore the correct answer. Choice B is incorrect because it multiplies the interest rate on debt by the marginal tax rate, rather than subtracting the tax rate from 1. Choice C is also incorrect because it does not account for the tax benefits of debt. Choice D is incorrect because it subtracts the product of the interest rate and tax rate from 1, which does not accurately reflect the adjusted discount rate for financial lease valuation.

If the Interest Rate on Debt Is RD, What Adjusted