The aftertax cost of which of the following are affected by a change in a firm's tax rate? I. preferred stock
II) debt
III) equity
IV) capital

Question

Quizplus · Accepted Answer

The aftertax cost of debt is affected by a change in a firm's tax rate because interest payments on debt are tax-deductible. Therefore, an increase in the firm's tax rate decreases the aftertax cost of debt and vice versa. The aftertax cost of preferred stock is unaffected by changes in tax rates because preferred stock dividends are not tax-deductible. The aftertax cost of equity is also unaffected by changes in tax rates because dividends and capital gains are not tax-deductible. The aftertax cost of capital is a weighted average of the aftertax costs of debt, preferred stock, and equity, so it is affected by changes in tax rates only to the extent that the aftertax cost of debt changes. Therefore, the best choice is B: II and IV only.

The Aftertax Cost of Which of the Following Are Affected