Answer whether the following statement is true false or unce

Answer whether the following statement is true, false or uncertain. Carefully justify your answers. If the corporate tax rate, the interest rate, and the depreciation rate all diminish, then the tax-adjusted user cost of capital will decrease.

Solution

Tax adjusted cost of capital (COC)= Proportion of debt x Pre-tax cost of debt x (1 - Tax rate) + Cost of equity x proportion of equity, where

Pre-tax cost of debt depends on interest rate. The higher the interest rate, the higher the pre-tax cost of debt.

If corporate tax rate goes down, (1 - tax rate) increases and so, COC increases. At the same time, interest rate falls, which lowers pre-tax cost of debt. So the net effect is uncertain.

Note: Depreciation rate doesn\'t directly affect cost of capital.