Which of the following statements is true of the impact of tax on the cost of ca

Question

Which of the following statements is true of the impact of tax on the cost of capital of a firm?

A. All else being equal, an increase in the equity capital that a firm raises by retaining earnings results in in the increase in the tax rate applicable to the firm.

B. All else being equal, an increase in the corporate tax rate results in a decrease in the weighted average cost of capital.

C. The tax paid on dividends of preferred stock reduces the amount of funds that the firm can use for financing capital budgeting projects.

D. The before-tax cost of debt is always less than the after-tax cost of debt of a firm.

E. The before-tax cost of debt is the cheapest component of the cost of capital since the tax paid is a deductible expense.

Explanation / Answer

correct option is "B" -All else being equal, an increase in the corporate tax rate results in a decrease in the weighted average cost of capital.

This is so Because with increase in tax rate ,After tax cost of debt decreases and thus Weighted average cost of capital will decrease .

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