Debt isn’t just a source of financing — the fact that interest is tax-deductible while dividends aren’t creates a real, quantifiable tax benefit purely from using debt.
How it works
Under Modigliani-Miller’s assumption of permanent debt, discounting the perpetual stream of interest tax shields at the same rate used to price the debt causes those terms to cancel out algebraically, leaving simply debt times the tax rate.
What this does not include
This does not include the more complex Miles-Ezzell or adjusted-present-value formulations used for debt that isn’t permanent (a fixed repayment schedule instead), which require a full multi-period present value calculation rather than this simplified perpetual-debt shortcut.
How to use this calculator
- Enter the amount of permanent debt and the corporate tax rate.
Frequently asked questions
Why does the tax shield’s value simplify so cleanly for permanent debt?
Because both the annual tax shield and its discount rate are tied to the same cost of debt — mathematically, those two terms cancel out of the present-value-of-a-perpetuity formula, leaving just debt times the tax rate.
Does this mean more debt is always better?
No — this formula captures only the tax benefit side; it ignores the real costs of financial distress and bankruptcy risk that rise with leverage, which is why companies don’t take on unlimited debt despite the tax shield.
Is this the same concept behind WACC being lower than the cost of equity?
Yes — the interest tax shield is exactly why WACC formulas use an after-tax cost of debt, embedding this same tax benefit directly into the discount rate used for company valuation.
