Question

The CFO of Bayern Mechanic is advocating for increasing debt in the capital structure of the firm by taking out a bank loan and repurchasing shares of stock. If Bayern’s current income tax rate is expected to decrease by 50%, will the capital structure change become more or less beneficial to the firm? Group of answer choices The benefit of the capital structure change is the same The capital structure change will be less beneficial No answer text provided. The capital structure change will be more beneficial

Answer 1

Answer: The capital structure change will be less beneficial

Step-by-step explanation:

The move would be less beneficial because the main advantage of Debt is that it is not Taxable. This means that having debt as a company gives you a sort of TAX SHIELD.

However, in the above scenario, the tax rate is due to decrease. This means that there is less of a reason to have a tax shield. It is therefore less beneficial to accrue more debts which can put the company in financial distress when there is no added benefit of a tax shield.