With the inclusion of taxes, MM I is incorrect and the capital structure of the firm can be important due to the:
A) lower tax rates on dividends than on debt.
B) higher tax rates on retained earnings than on debt.
C) lower tax liability due to interest deductibility.
D)higher operating income from lower dividends.

Question

Quizplus · Accepted Answer

The lower tax liability due to interest deductibility is the reason why the capital structure of the firm can be important with the inclusion of taxes. The deductibility of interest payments on debt reduces the taxable income and thus the tax liability of the firm. This makes debt financing more attractive than equity financing which is not tax-deductible. Therefore, the capital structure of the firm affects its tax liability and the after-tax cost of capital.

With the Inclusion of Taxes, MM I Is Incorrect and the Capital