If Congress were to pass a law allowing only half a firm's interest expense to be tax deductible, how would this affect the relative value of firms, all else equal?

Question

Quizplus · Accepted Answer

The law would decrease the value of firms with higher marginal tax rates the most because they rely more heavily on the tax deductibility of interest expenses to lower their overall tax liability. Firms with lower marginal tax rates would be less affected since they already have lower tax liabilities and are less reliant on the deductibility of interest expenses. This would decrease the tax shield from interest expenses for all firms. However, since firms with higher marginal tax rates benefit more from the tax shield, they would be negatively affected to a greater extent than firms with lower marginal tax rates. As a result, the value of firms with higher marginal tax rates would decrease the most.

If Congress Were to Pass a Law Allowing Only Half