How are cash flows to investors calculated when leverage is involved?

Cash flows to investors when leverage is involved are calculated by adding the cash flows to investors without leverage to the interest tax shield. The fundamental reason for this calculation is that leverage impacts a company’s cash flows due to the way debt financing alters tax obligations and the potential cash available for reinvestment or distribution.

In a leveraged scenario, the interest payments on debt reduce taxable income because they are tax-deductible expenses. This creates an interest tax shield, which effectively increases the cash flows available to equity and debt holders after accounting for these tax savings. Therefore, when calculating cash flows to investors, it is crucial to include both the base cash flows generated by the company (as if it were unlevered) and the additional benefit derived from the interest tax shield.

In a simplified perspective, the total cash flow to investors is enhanced by the value of the interest tax shield because it represents a real cash benefit arising from the company's financing strategy. This approach highlights how debt financing can provide financial advantages while also providing insight into how the risk-return profile alters for both equity and debt investors.

The other options do not accurately capture the mechanism through which cash flows to investors are calculated in the presence of leverage, particularly how the tax benefits from debt impact the overall cash flows