Final answer:
The correct option: The interest tax shield reduces a firm's taxes by the amount of interest on its debt.
Step-by-step explanation:
The correct statement that accurately describes the concept of the interest tax shield is option c) The interest tax shield reduces a firm's taxes by the amount of interest on its debt.
The interest tax shield refers to the tax advantage that a company receives when it deducts the interest expense on its debt from its taxable income. By deducting the interest expense, a firm's taxable income is reduced, resulting in a lower tax liability.
For example, let's say a company has $1 million in taxable income and $100,000 in interest expense on its debt. If the tax rate is 30%, the company's tax liability without the interest tax shield would be $300,000. However, with the interest tax shield, the company can deduct the $100,000 interest expense, reducing its taxable income to $900,000. Applying the 30% tax rate, the company's tax liability is now $270,000. Therefore, the interest tax shield reduces the firm's taxes by $30,000 ($300,000 - $270,000).