Joseph Palmer is discussing the impact of the tax shield provided by debt with his supervisor, Ming Chou. During the course of their discussion, Palmer makes the following statements:
| Statement 1: |
The value of the tax shield provided by debt can be calculated by multiplying the pre-tax cost of debt by (1 – tax rate).
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| Statement 2: |
If a company is profitable, the value of its tax shield will be positive and its value will increase as its leverage increases, all else equal. |
With respect to Palmer’s statements:
A. only one is correct.
B. both are correct.
C. both are incorrect.
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