Option A Explain?, Aslo looking correct!
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Option B is the correct answer. As Kd < Ke and Kpe (Debt is less costly because debt holders will receive timely interest component & debt holders line mein sabse pehle lagte hai in the liquidation or in the bankruptcy proceedings to get their claims, interest tax shield makes it even less costly).
Option A says that use average tax rate as interest is tax deductible against the company’s entire taxable income which is wrong. Let’s understand this:
Revenue 100
COGS 40
GP 60
SGA expense 20
EBITDA 40
Dep & Amort 10
EBIT 30
Interest expense 10
PBT 20
Tax expense 5
Effective tax rate = 5/20 = 25%
PAT 15
We should use effective tax rate in order to calculate cost of debt.
Refer to this paragraph from “Investopedia”