The Power of Tax Deductible Debt

Abstract

The relationship (V_L=V_u+t_cB) is very powerful and provides useful insights, even though it unrealistically implicitly assumes zero tax investors or the equivalent and zero costs of financial distress. But now in order to stress the power of tax deductible debt we will switch to an internal rate of return (IRR) analysis of the benefits of debt. We will assume that t_c = .35 and the debt is purchased by zero tax investors and the common stock is purchased by investors where t_p = .36 and t_g = .18.