Assume perfect capital markets except that taxes DO exist. Why does th

Assume perfect capital markets except that taxes DO exist. Why does the value of the interest tax shield accrue entirely to the shareholders and none of the value goes to the bondholders?

What will be an ideal response?

ANSWER

The value of the firm increases by the value of the interest tax shield which is the present value of the reduction in taxes paid. The tax shield does not impact the cash flows contracted to bondholders thus the entire value must go to the shareholders.