Question

Other things remaining the same, an increase in the tax rate on corporate profits will:

• A. None of these
• B. make the debt relatively the dearer
• C. have no impact on the cost of debt
• D. make the debt relatively cheaper

Answer 1

The correct option is D

make the debt relatively cheaper

Cost of Debt is affected by tax rate because Interest on Debt is a deductible expense. A higher tax rate, thus, makes debt relatively cheaper as compared to equity. For Example: If the firm borrows @10% and tax rate is @30%, then the after cost of debt will be @7%.