Asked by Mohamad Arshil Vahora on Jul 16, 2024
Verified
Which statement regarding debt is correct,other things held constant?
A) Firms whose assets are relatively liquid tend to have relatively low bankruptcy costs; hence, they tend to use relatively little debt.
B) An increase in the personal tax rate is likely to increase the debt ratio of the average corporation.
C) An increase in the company's degree of operating leverage is likely to encourage a company to use more debt in its capital structure.
D) An increase in the corporate tax rate is likely to encourage a company to use more debt in its capital structure.
Debt Ratio
A financial ratio that measures the proportion of a company's total debt to its total assets, indicating its leverage level.
Operating Leverage
A measure of a company's fixed versus variable costs, indicating how a company's operating income changes in response to changes in sales volume.
Corporate Tax Rate
The rate at which a corporation is taxed on its income. This rate varies by country and sometimes within regions of a country.
- Interpret the impact of debt financing on the valuation of firms and the cost incurred for capital.
Verified Answer
ST
shahanaz TamannaJul 18, 2024
Final Answer :
D
Explanation :
An increase in the corporate tax rate makes debt financing more attractive because interest payments on debt are tax-deductible, which can reduce a company's taxable income and thus its tax liability. This tax shield effect encourages companies to use more debt in their capital structure.
Learning Objectives
- Interpret the impact of debt financing on the valuation of firms and the cost incurred for capital.