Answer: remains the same.

## Explanation When interest expense is **not tax deductible**, the tax shield benefit of debt financing is eliminated. The Weighted Average Cost of Capital (WACC) formula is: \[ WACC = \frac{E}{V} \times r_e + \frac{D}{V} \times r_d \times (1 - T) \] Where: - \(E/V\) = proportion of equity in capital structure - \(r_e\) = cost of equity - \(D/V\) = proportion of debt in capital structure - \(r_d\) = cost of debt - \(T\) = marginal tax rate **Key insight:** When interest expense is not tax deductible, the term \((1 - T)\) becomes irrelevant because there is no tax shield. The after-tax cost of debt is simply \(r_d\) (not \(r_d \times (1 - T)\)). Therefore, the WACC formula simplifies to: \[ WACC = \frac{E}{V} \times r_e + \frac{D}{V} \times r_d \] **Since the tax rate \(T\) does not appear in this simplified formula**, changes in the marginal tax rate have **no effect** on WACC when interest expense is not tax deductible. **Why other options are incorrect:** - **A (decreases)**: This would be true if interest expense were tax deductible, as higher tax rates increase the tax shield benefit, reducing the after-tax cost of debt. - **C (increases)**: There's no mechanism for WACC to increase with tax rates when interest is not deductible, as the tax rate doesn't affect the calculation. **Conclusion:** With no tax deductibility of interest, WACC remains unchanged regardless of changes in the marginal tax rate.

Author: LeetQuiz .