A Revisited Version of the Cost of Capital. The Irrelevance of the Partial Interest Tax Deductibility on Investment and Financing Decisions

The purpose of this paper is to investigate the interest tax deductibility effect on cost of capital under earning stripping rules recalling Modigliani-Miller's theorem (1958, 1963). In fact, Italy's corporate taxation, as other countries, does not allow to fully deduct interest expenses of debt but it imposes a threshold by linking the interest tax deductibility to the ebitda driver. This limit could reduce the tax shield benefit for firms with higher financial leverage, creating a misconception about optimal capital structure and firm value. The findings have led to an adjustment of the weighted average cost of capital (WACC) formula analysing the single and multi-period analysis by which in both cases the limitation is irrelevant in terms of optimal capital structure decision and firm value