In a world with corporate taxes, the increase in the ﬁrm's optimal debt level is determined by discounting a future guaranteed after-tax inﬂow at:
A)the risk-free rate.
B)the ﬁrm's weighted average cost of capital (WACC).
C)the after-tax riskless interest rate.
D)the before-tax borrowing rate.
E)the discount rate of a similar lease.

Question

Quizplus · Accepted Answer

The increase in the firm's optimal debt level in a world with corporate taxes is determined by discounting a future guaranteed after-tax inflow at the after-tax riskless interest rate. This reflects the tax shield benefit of debt financing, where interest payments on debt reduce taxable income, thus the after-tax cost of debt is used for discounting.

In a World with Corporate Taxes, the Increase in the ﬁRm's