Which of the following statements is false?

1. By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes increases.

2. To determine the benefit of leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive.

3. When a firm uses debt, the interest tax shield provides a corporate tax benefit each year.

4. Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield, by the Law of One Price the same must be true for the present values of these cash flows.

Question

Business

Siena

25 September, 12:50

Which of the following statements is false?

1. By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes increases.

2. To determine the benefit of leverage for the value of the firm, we must compute the present value of the stream of future interest tax shields the firm will receive.

3. When a firm uses debt, the interest tax shield provides a corporate tax benefit each year.

4. Because the cash flows of the levered firm are equal to the sum of the cash flows from the unlevered firm plus the interest tax shield, by the Law of One Price the same must be true for the present values of these cash flows.

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Answers (1)

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Alina English · Answer 1

1) By increasing the amount paid to debt holders through interest payments, the amount of the pretax cash flows that must be paid as taxes increases.

Explanation:

All businesses pay taxes based on their net profits after interest payments are deducted as expenses, therefore interest payments reduce the net profit. A lower net profit = lower corporate taxes paid. Only interest payments are considered expenses, principal payments are not considered expenses and don't reduce taxes.