What is the tax advantage of using debt over equity in a firm's capital structure?

The tax advantage of using debt over equity primarily stems from the fact that interest payments on debt are tax deductible. This means that when a firm pays interest on its debt, it can deduct these payments from its taxable income, effectively lowering its overall tax liability. This tax shield provided by debt can make financing through debt more attractive relative to equity, where dividend payments are made from after-tax income and are not deductible.

When a firm utilizes debt in its capital structure, it can enhance its value through this tax shield, which can lead to a cost of capital that is lower than that associated with equity financing. This incentive often leads firms to prefer debt, as it can improve return on equity for shareholders while also taking advantage of tax-related benefits.

In contrast, while ease of acquisition, voting rights, and collateral requirements are important considerations when choosing between debt and equity, they do not represent the specific tax advantages that debt financing offers in the context of capital structure decisions.