Which of the following will tend to diminish the benefit of the interest tax shield given a progressive tax rate structure?
I. A reduction in tax rates
II. A large tax loss carryforward
III. A large depreciation tax deduction
IV. A sizeable increase in taxable income
A) I and II only
B) I and III only
C) II and III only
D) I, II, and III only
E) I, II, III, and IV

Question

Quizplus · Accepted Answer

I. A reduction in tax rates: If tax rates are reduced, the benefit of the interest tax shield will also reduce.
II. A large tax loss carryforward: A large tax loss carryforward reduces the company's taxable income, which reduces the benefit of the interest tax shield.
III. A large depreciation tax deduction: A large depreciation tax deduction reduces the taxable income and, therefore, reduces the benefit of the interest tax shield.
IV. A sizeable increase in taxable income: A sizeable increase in taxable income increases the company's tax liability, making the interest tax shield more valuable. However, this option does not diminish the benefit of the interest tax shield, but instead enhances it. Therefore, option IV is incorrect. 
Therefore, options I, II, and III are the correct answers, as they diminish the benefit of the interest tax shield.

Which of the Following Will Tend to Diminish the Benefit