The tax shield on debt has no value for a firm when: A)the firm's debt-equity ratio is exactly equal to 1. B)the firm's debt-equity ratio is exactly .5. C)the firm is unlevered. D)shareholders fully utilize homemade leverage. E)R_S is less than R₀.

Question

Quizplus · Accepted Answer

The tax shield on debt is only applicable when a firm has debt. If the firm is unlevered, there is no debt to provide a tax shield. Therefore, option C is the correct choice. Option A and B are incorrect because as long as there is debt, there will be a tax shield, regardless of the specific debt-equity ratio. Option D is also incorrect because even if shareholders fully utilize homemade leverage, the firm may still have debt and therefore can benefit from a tax shield. Option E is irrelevant to the question since it does not relate to the tax shield on debt.

The Tax Shield on Debt Has No Value for a Firm