As the level of debt increases the tax benefits of debt increase until ________.

Question

Quizplus · Accepted Answer

Tax benefits of debt refer to the tax shield benefit that a company receives from deducting interest expenses from taxable income. As debt levels increase, so do interest payments, which increase the tax shield benefit. However, at some point, the costs of financial distress, such as bankruptcy or default, may outweigh the benefits of the tax shield. Thus, the tax benefits of debt increase until the distress costs exceed the benefit, which is known as the optimal capital structure.

As the Level of Debt Increases the Tax Benefits of Debt