Refer to the following figure when answering the following questions.
Figure 17.1: Capital Arbitrage
-Consider Figure 17.1. If there is a decrease in the corporate tax rate, then curve ________ would shift to curve ________.
A) d; c
B) b; a
C) c; d
D) a; b
E) Not enough information is given.

Question

Refer to the following figure when answering the following questions.
Figure 17.1: Capital Arbitrage 
-Consider Figure 17.1. If there is a decrease in the corporate tax rate, then curve ________ would shift to curve ________.
A) d; c 
B) b; a 
C) c; d 
D) a; b 
E) Not enough information is given.

Quizplus · Accepted Answer

In Figure 17.1, we can see that curve c represents the effective cost of debt for the firm before taxes, while curve d represents the effective cost of debt for the firm after taxes. If there is a decrease in the corporate tax rate, then the tax shield associated with debt financing would decrease, resulting in an increase in the effective cost of debt. This would cause curve d to shift to curve c, as the cost of debt increases. Therefore, the correct answer is (C) c; d.

Refer to the Following Figure When Answering the Following Questions