The interest tax shield has no value for a ﬁrm when: I.the tax rate is equal to zero.
II)the debt-equity ratio is exactly equal to 1.
III)the ﬁrm is unlevered.
IV)a ﬁrm elects 100% equity as its capital structure.
A)I and III only.
B)II and IV only.
C)I, III, and IV only.
D)II, III, and IV only.
E)I, II, and IV only.

Question

Quizplus · Accepted Answer

The interest tax shield refers to the tax saving achieved by a firm due to the tax-deductible nature of interest expenses. It has no value when the tax rate is zero (I) because there are no taxes to save on, when the firm is unlevered (III) because there is no debt and thus no interest expense to deduct, and when a firm elects 100% equity as its capital structure (IV) because, again, there is no debt. The debt-equity ratio being equal to 1 (II) does not inherently negate the value of the interest tax shield.

The Interest Tax Shield Has No Value for a ﬁRm