Question

Which of the following statements is FALSE?

A. Because corporations pay taxes on their profits after interest payments are deducted, interest expenses reduce the amount of corporate tax firms must pay.

B. The gain to investors from the tax deductibility of interest payments is referred to as the interest tax shield.

C. The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage.

D. By increasing interest payments to debt holders, the amount of pre-tax cash flows that must be paid as taxes increases.

Answer 1

Ans- Option D. By increasing interest payments to debt holders, the amount of pre-tax cash flows that must be paid as taxes increases.

As when the interest payments increases to bond holders, the pre tax cash flows decreases which decreases the taxess o be paid.

- Interest is a tax deductibel Expenses, thus it educe the amount of corporate tax firms must pay

- Interest tax shield = Interest payment(Tax rate). So. Interest tax shiled is the tax gain earned from Interest.

- If leverage was not there, no Interest tax shiled would have arisen.