The tax benefit is attracted in case of which of the following element of cost of capital ?

The correct answer is - Cost of debt

Key Points

• Cost of debt
  • Tax benefits are associated with the interest expense on debt because interest is considered a tax-deductible expense.
  • This reduces the effective cost of borrowing for companies, making debt financing more attractive compared to equity or preference shares.
  • For example, if a company has a corporate tax rate of 30% and pays 10% interest on debt, the effective cost of debt after tax is 7% (10% × (1 - 0.30)).
  • This tax benefit does not apply to other components of the cost of capital like equity, preference shares, or retained earnings.

Additional Information

• Cost of equity
  • Equity financing does not attract tax benefits as dividends are not tax-deductible.
  • The cost of equity is calculated using models like the Capital Asset Pricing Model (CAPM), which considers the risk-free rate, market return, and beta of the stock.
• Cost of preference shares
  • Dividends on preference shares are not tax-deductible, and hence, no tax benefit is available.
  • The cost of preference shares is the fixed dividend rate divided by the issue price.
• Cost of retained earnings
  • Retained earnings represent the company's internal funds and do not provide any tax benefits.
  • The cost of retained earnings is equivalent to the opportunity cost of reinvesting earnings into the business rather than distributing them as dividends.