The tax shield on debt is one reason why:
A)the required rate of return on assets rises when debt is added to the capital structure.
B)the value of an unlevered firm is equal to the value of a levered firm.
C)the net cost of debt to a firm is generally less than the cost of equity.
D)the cost of debt is equal to the cost of equity for a levered firm.
E)firms prefer equity financing over debt financing.

Question

Quizplus · Accepted Answer

The tax shield on debt reduces the net cost of debt to a firm, making it generally less than the cost of equity. This is because interest payments on debt are tax-deductible, reducing the amount of taxable income and therefore, the amount of taxes a firm has to pay. This lowers the overall cost of debt to a company compared to equity financing.

The Tax Shield on Debt Is One Reason Why