The change in ﬁrm value in the presence of corporate taxes only is:
A)positive as equityholders face a lower effective tax rate.
B)positive as equityholders gain the tax shield on the debt interest.
C)negative because of the increased risk of default and fewer shares outstanding.
D)negative because of a reduction of equity outstanding.
E)None of the above.

Question

Quizplus · Accepted Answer

When a firm takes on debt, it gains tax shield on interest payments since interest expenses are tax deductible. This tax shield benefits equityholders by reducing the firm's overall tax liability, which increases the firm's value. Therefore, the presence of corporate taxes can have a positive effect on firm value as equityholders gain the tax shield on the debt interest.

The Change in ﬁRm Value in the Presence of Corporate