An increase in the tax rate ________ the optimal debt-to-equity ratio. It ________ the after-tax cost of debt. Assume all else equal.
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A. B. C. D. E. F.E
Since interest payments are tax deductible, higher tax rates make debt more attractive relative to equity, increasing the optimal D/E ratio. The after-tax cost of debt decrease, assuming that the pre-tax cost of debt is not affected by the change in the tax rate (in reality, it could increase due to decreased profitability of the firm and the resultant decrease in its solvency).