Question

In the presence of corporate taxes, the value of a levered firm is higher than the value of an unlevered firm owing to the tax shield benefit of blank.

Option 1: Flotation costs
Option 2: Debt
Option 3: Dividends
Option 4: Depreciation

Answer 1

The value of a levered firm is higher than an unlevered firm due to the tax shield benefit of debt, as interest payments are tax-deductible and reduce the firm's taxable income, enhancing its value.

Step-by-step explanation:

In the context of corporate finance, the value of a levered firm is higher than the value of an unlevered firm in the presence of corporate taxes due to the tax shield benefit of debt.

This tax shield occurs because the interest payments on debt are tax-deductible, reducing the firm's taxable income and thus its tax liability. When a firm chooses financing options, including borrowing from a bank or issuing bonds, it gains an advantage over issuing stock as it does not have to give up control or equity in the company.

However, this approach also commits the firm to make regular interest payments, which could be a burden if the income is not sufficient. Nonetheless, the tax savings from interest deductibility contribute to the increased value of a firm with leverage—the core idea behind the renowned Modigliani-Miller theorem when corporate taxes are considered.