Other things remaining the same, an increase in the tax rate on corporate profits will:
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → make the debt relatively cheaper
When the tax rate on corporate profits increases, companies get a higher tax shield on the interest paid on debt, because interest expenses are tax-deductible. This reduces the effective cost of debt, making debt financing relatively cheaper compared to equity, whose dividends are not tax-deductible.