Chapter 15
Debt and Taxes
I. Chapter Outline
The following chapter outline is correlated to the PowerPoint Lecture Slides. The PowerPoint slides
are referenced in bold. Alternative Examples to selected textbook examples are also available in the
PowerPoint Lecture Slides and are also referenced in bold.
15.1 The Interest Tax Deduction (Slides 6–11)
• Table 15.1 Macy’s Income with and without Leverage, Fiscal Year 2014 ($ million)
15.2 Valuing the Interest Tax Shield (Slide 16)
• The Interest Tax Shield and Firm Value (Slides 17, 19)
• Figure 15.1 The Cash Flows of the Unlevered and Levered Firm (Slide 18)
• Example 15.2 Valuing the Interest Tax Shield without Risk (Slides 20–21)
• PowerPoint Alternative Example 15.2 (Slides 22–23)
15.3 Recapitalizing to Capture the Tax Shield (Slide 39)
• The Tax Benefit (Slides 40–42)
• The Share Repurchase (Slides 43-45)
15.4 Personal Taxes (Slides 56–57)
• Including Personal Taxes in the Interest Tax Shield (Slides 58–59, 61-63)
• Figure 15.3 After-Tax Investor Cash Flows Resulting from $1 in EBIT (Slide 60)
• Table 15.3 Top Federal Tax Rates in the United States, 1971–2015 (Slide 61)
64 Berk/DeMarzo • Corporate Finance, Fourth Edition
15.5 Optimal Capital Structure with Taxes (Slide 83)
• Do Firms Prefer Debt? (Slides 83, 85, 87)
• Figure 15.5 Net External Financing and Capital Expenditures by U.S. Corporations
(1975–2014) (Slide 84)
• Figure 15.6 Debt-to–Value Ratio (D/(E + D) of U.S. Firms, 1975–2014 (Slide 86)
• Figure 15.7 Debt-to–Value Ratio (D/(E + D) for Select Industries (2015) (Slides 88-89)
II. Learning Objectives
15-2 Calculate the interest tax shield, given the corporate tax rate and interest payments.
15-4 Calculate the weighted average cost of capital with corporate taxes.
15-6 Describe the effect of personal taxes on the corporate tax benefits of leverage.
15-8 Discuss why the optimal level of leverage from a tax-saving perspective is the level at which
interest equals EBIT.
15-10 Assess the apparent under-leveraging of corporations, both domestically and internationally.
Berk/DeMarzo • Corporate Finance, Fourth Edition 65
III. Chapter Overview
The motivation for this chapter is empirical observation of corporate capital structure. In particular, if
capital structure is unimportant, why do we see consistent differences in capital structure across firms
and industries? Also, why do managers spend time thinking about capital structure if it is irrelevant?
15.1 The Interest Tax Deduction
15.2 Valuing the Interest Tax Shield
This section of the chapter shows how to calculate the value of the levered firm. Equation 15.2 is a
15.3 Recapitalizing to Capture the Tax Shield
The authors first compute the value of the levered firm, then subtract the debt value to show the new
value of equity. If the stock is repurchased at its pre-recapitalization rate, then the stock price will
15.4 Personal Taxes
This section includes the consequences of the combination of personal and corporate taxes. Table
15.3 shows top federal tax rates in the United States during the last 34 years. Figure 15.3 is a visual
aid to understanding how taxes are paid, so that equation 15.7, showing the effective tax advantage of
2014. This chart indicates that most companies raise external capital using debt. However, market
value of equity continues to increase as firms retain earnings so that the market value debt to equity
ratio is about 36% on average. Figure 15.7 shows debt as a fraction of firm value by industry and for
the market. It is clear that there are large differences across industries.
There are several explanations for this difference. First, in order to receive tax benefits, a
66 Berk/DeMarzo • Corporate Finance, Fourth Edition
that exceed EBIT are discussed in Chapter 16. When EBIT is uncertain, the tax savings declines for
IV. Spreadsheet Solutions in Excel
The following Problems for Chapter 15 have spreadsheet versions of the problems available: 4, 5, 7,
and 27.
These spreadsheets can be downloaded from the Instructor’s Resource Center at: