Why does the tax amount need to be adjusted when valuing a firm using the cash flow from assets approach?
A) The tax effect of the dividend payments must be eliminated.
B) Only straight-line depreciation can be used when computing taxes for valuation purposes.
C) Taxes must be computed for valuation purposes based solely on the marginal tax rate.
D) The tax effect of the interest expense must be removed.
E) The taxes must be computed for valuation purposes based on the average tax rate for the past ten years.

Question

Quizplus · Accepted Answer

The cash flow from assets approach calculates the cash flows available to all investors in the firm, including both bondholders and equity investors. Since interest expense is tax-deductible, it reduces the taxable income of the firm, resulting in a tax shield. To accurately value the firm, we need to remove the tax effect of interest expense so that we are left with the after-tax operating income. This requires adjusting the tax amount used in the calculation.

Why Does the Tax Amount Need to Be Adjusted When