All else the same, which of the following is true about the interest tax shield of a ﬁrm with positive EBIT?
A) The higher the corporate tax rate, the less valuable the interest tax shield.
B) If the ﬁrm dramatically increases its depreciation expense, it may have more of a need for an interest tax shield.
C) The interest tax shield becomes more valuable as the size of the debt load increases.
D) The interest tax shield increases as a ﬁrm reduces its level of outstanding debt.
E) Since the interest tax shield is valuable, the ﬁrm would rather pay a high coupon rate on its bonds than a low coupon rate.

Question

Quizplus · Accepted Answer

The interest tax shield becomes more valuable as the size of the debt load increases because interest expense is tax-deductible. Therefore, the higher the debt level, the more tax saved through the interest tax shield. The other options are incorrect. A higher corporate tax rate makes the interest tax shield more valuable, not less valuable (A). Increasing depreciation expense does not necessarily create more need for an interest tax shield (B). The interest tax shield decreases as the firm reduces its level of outstanding debt (D). A lower coupon rate means less interest expense and therefore a smaller interest tax shield, so the firm would prefer a higher coupon rate (E) to maximize the interest tax shield.

All Else the Same, Which of the Following Is True