Cost of Capital: Cost of Debt after Tax

A company is fully equity financed. Its pre-tax cost of equity is estimated to be 16%. If the marginal tax rate goes down by 6%, it will _most likely_ cause the after-tax cost of equity to:

Incorrect. This answer choice does not take into account the differential tax treatment between the cost of debt and the cost of equity.

Incorrect. A decrease in the company's tax rate will decrease the tax benefits reflected in the cost of debt, and not serve to lower the cost of capital for a company financed fully with equity.

Correct! The cost of equity is not tax-deductible. Hence, the after-tax cost of equity is not affected by a change in the tax rate.

increase.

decrease.

remain unchanged.