Impact of corporate income tax on weighted average cost of capital: evidence from financial simulation
Keywords:
Corporate Income Tax, WACC, Tax Shield, Firm Valuation, Financial SimulationAbstract
Introduction: Corporate capital structure is influenced by financial and fiscal factors. Income tax affects the cost of debt through the tax shield, modifying the weighted average cost of capital (WACC).
Objective: To analyze the effect of variations in corporate income tax rates on WACC and firm value through financial simulation.
Method: A quantitative, non-experimental study based on financial modeling is conducted. A representative firm is simulated under five tax scenarios (20%, 25%, 30%, 35% and 40%). WACC and present value of projected cash flows are calculated over ten years.
Result: Higher tax rates reduce WACC due to the increased tax shield, slightly increasing firm value when leverage remains constant.
Conclusions: Tax rates influence capital cost nonlinearly. The fiscal benefit of debt enhances valuation but raises financial risk exposure.
Empirical contribution: The study provides quantitative evidence on WACC sensitivity to tax rate variations using controlled financial simulation.
References
Auerbach, A. J. (2002). Taxation and corporate financial policy. Handbook of Public Economics, 3, 1251–1292. https://doi.org/10.1016/S1573-4420(02)80005-3
Brealey, R. A., Myers, S. C., & Allen, F. (2014). Principles of corporate finance (11th ed.). McGraw Hill Education.
DeAngelo, H., & Masulis, R. W. (1980). Optimal capital structure under corporate and personal taxation. Journal of Financial Economics, 8(1), 3–29. https://doi.org/10.1016/0304-405X(80)90019-7
Fama, E. F., & French, K. R. (2002). Testing trade-off and pecking order predictions about dividends and debt. Review of Financial Studies, 15(1), 1–33. https://doi.org/10.1093/rfs/15.1.1
Feld, L. P., Heckemeyer, J. H., & Overesch, M. (2013). Capital structure choice and company taxation: A meta-study. Journal of Banking & Finance, 37(8), 2850–2866. https://doi.org/10.1016/j.jbankfin.2013.03.017
Frank, M. Z., & Goyal, V. K. (2009). Capital structure decisions: Which factors are reliably important? Financial Management, 38(1), 1–37. https://doi.org/10.1111/j.1755-053X.2009.01026.x
Graham, J. R. (2000). How big are the tax benefits of debt? Journal of Finance, 55(5), 1901–1941. https://doi.org/10.1111/0022-1082.00277
Hamada, R. S. (1972). The effect of the firm's capital structure on the systematic risk of common stocks. of Finance, 27(2), 435–452. https://doi.org/10.1111/j.1540-6261.1972.tb00971.x
Jensen, M. C., & Meckling, W. H. (1976). Theory of the firm: Managerial behavior, agency costs and ownership structure. Journal of Financial Economics, 3(4), 305–360. https://doi.org/10.1016/0304-405X(76)90026-X
Kraus, A., & Litzenberger, R. H. (1973). A state-preference model of optimal financial leverage. Journal of Finance, 28(4), 911–922. https://doi.org/10.1111/j.1540-6261.1973.tb01415.x
Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios. Review of Economics and Statistics, 47(1), 13–37. https://doi.org/10.2307/1924119
Miller, M. H. (1977). Debt and taxes. Journal of Finance, 32(2), 261–275. https://doi.org/10.1111/j.1540-6261.1977.tb03267.x
Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment.
