What's wrong with this statement

This is one of the answer choices in multiple choice question:

“The appropriate tax rate to use in the adjustment of the before-tax cost of debt to determine the after-tax cost of debt is the average tax rate because interest is deductible against the company’s entire taxable income.”

I would really appreciate your help.


The problem with that statement is that if you have one more dollar in interest expense, the tax rate applied to that extra dollar will be the marginal tax rate, not the average tax rate. If, for example, a company’s marginal tas rate is 30% and its average tax rate is 20%, an extra $1.00 in interest expense will reduce its taxable income by $1.00, saving it $0.30 in taxes (not saving it $0.20 in taxes).

^I was thinking the same thing, but I didn’t want to speak up, because CFAI’s tax theory is very different from the IRS’s tax theory.

You’re hampered by having to work in the real world.

I feel for you.

Thanks S2000magician!

You’re welcome.