Given corporate taxes, why does adding debt to the capital structure increase firm value?
A)Extra cash flow goes to the firm's investors rather than the tax authorities.
B)Earnings before interest and taxes are fully taxed at the corporate rate.
C)Personal tax rates are the same as marginal corporate tax rates.
D)Earnings before interest and taxes are fully taxed at the corporate rate, and personal tax rates are the same as marginal corporate tax rates.

Question

Quizplus · Accepted Answer

When a firm adds debt to its capital structure, it increases the amount of interest payments it must make to bondholders. These interest payments are tax-deductible expenses, which means that the firm's taxable income is reduced, and it pays less in corporate taxes. As a result, more cash flow is available to the firm's investors (shareholders), which increases the firm's overall value.

Given Corporate Taxes, Why Does Adding Debt to the Capital