How does the tax deductibility of interest affect the value of a levered firm compared to an unlevered firm according to M&M Proposition I with corporate taxes?

The tax deductibility of interest increases the value of a levered firm compared to an unlevered firm. According to M&M Proposition I with corporate taxes, the value of a levered firm equals the value of an unlevered firm plus the present value of the interest tax shield, represented as VL = VU + TC × D.

This proposition indicates that the tax shield from interest payments provides a financial advantage to levered firms, resulting in a higher overall firm value. For example, if a firm has debt, the tax savings from the interest expense contribute positively to the firm's cash flows, thus enhancing its valuation compared to a firm without debt.