In MM with taxes, what term represents the tax shield from debt that increases firm value?

• A. Tc+D
• B. Tc*D
• C. D/Tc
• D. Tc-D

Answer: (B)

The key idea is the tax shield from debt, which increases the value of the firm. In a world with taxes, interest on debt is tax-deductible, so the company saves taxes equal to the tax rate times the interest expense. When debt is present, that tax saving translates into added value for the firm. In the standard Modigliani–Moss framework with taxes, the present value of this tax shield is Tc times D, meaning the levered firm’s value rises by Tc · D relative to the unlevered case. So the term that represents the tax shield from debt and how it boosts value is Tc multiplied by D.

This differs from the other expressions: Tc + D would imply simply adding the tax rate to debt, which doesn’t quantify any tax savings. D/Tc is a ratio, not a value of the tax shield. Tc − D would subtract debt from the tax rate, which has no meaningful interpretation as a tax shield.