Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

7. Receivables and Investments

Introduction to Investments in Securities

Financial Accounting

7. Receivables and Investments

Introduction to Investments in Securities

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Multiple Choice

An increase in a levered firm's tax rate will:

Increase the value of the interest tax shield, thereby increasing the firm's value.

Reduce the firm's cost of equity.

Decrease the value of the interest tax shield, thereby decreasing the firm's value.

Have no effect on the value of the interest tax shield.

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Verified step by step guidance

Understand the concept of the interest tax shield: The interest tax shield refers to the reduction in taxable income due to the deduction of interest expenses. This is a benefit for levered firms (firms with debt) because interest payments are tax-deductible.

Recognize the relationship between the tax rate and the interest tax shield: The value of the interest tax shield is calculated as the product of the tax rate and the interest expense. Mathematically, it can be expressed as:

Interest Tax Shield = Tax Rate \times Interest Expense

Analyze the impact of an increase in the tax rate: If the tax rate increases, the value of the interest tax shield will also increase because the tax rate is directly proportional to the interest tax shield. This means the firm saves more on taxes due to the deductibility of interest expenses.

Connect the increase in the interest tax shield to the firm's value: Since the interest tax shield represents a tax saving, an increase in its value enhances the overall value of the firm. This is because the firm retains more cash flow due to reduced tax liability.

Evaluate the other options provided in the problem: The increase in the tax rate does not reduce the firm's cost of equity, nor does it decrease the value of the interest tax shield. It also does not leave the interest tax shield unaffected. Therefore, the correct interpretation is that an increase in the tax rate increases the value of the interest tax shield, thereby increasing the firm's value.