Question

If we extend the MM's framework by corporate taxes (but no distress costs) then

a) Equity becomes more attractive because it is subject to corporate tax and we can take advantage of the tax shield

b) Interest payments on debt are tax deductible which increases the Weighted average cost of capital for high levels of debt relative to the standard MM framework

c) The present value of future tax savings increases the market value of the firm

d) More than one answer is correct

Answer 1

When the tax shield that will be resulting out of the tax detectable interest payment will be making the value of levered company higher than the value of unlevered company and it can be said that the present value of future tax saving increase the market value of company.

All the other options are false as we donot have to consider distress cost and interest payment on the debt are tax deductible which will be lowering the overall weighted average cost of capital.

Correct answer is option ( C) the present value of future tax saving increases the market value of firm