Question

Which of the following is true regarding a reasonable choice for a discount rate to apply to interest tax savings?

Choices ==v

a) If the firm is expected to decrease its debt ratio, you should use the expected return on the firmʹs equity, E(requity)

b) If the firm is expected to maintain a constant debt ratio, you should use the firmʹs weighted average cost of capital, WACC                                                         
                                   

c) If the firm is expected to increase its debt ratio, you should use the expected return on the firmʹs debt, E(rdebt)

d) None of them are true

Answer 1

If the firm is maintaining a constant and optimum mix of debt and equity, it is always preferable to use the Weighted average cost of capital as it helps in finding the rate of discounting which can be used in regards with different projects.

So Statement (B) If the firm is expected to maintain a constant debt ratio, you should use the firmʹs weighted average cost of capital, WACC is TRUE.

Rest of the statements are not true as you can't use cost of debt When debt is Increased and cost of equity when equity is Increased because there will always be a significant proportion of other capital financing.

So STATEMENT (B) IS TRUE.