Taxes and MM Proposition I

Because the debt is perpetual, the same $24 shield will be generated every year forever. The aftertax cash flow to L will thus be the same $700 that U earns plus the $24 tax shield. Because L's cash flow is always $24 greater, Firm L is worth more than Firm U, the difference being the value of this $24 perpetuity.

Because the tax shield is generated by paying interest, it has the same risk as the debt, and 8 percent (the cost of debt) is therefore the appropriate discount rate. The value of the tax shield is thus:

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