What element of a DCF does the tax rate specifically affect when the company has debt?

The tax rate specifically affects both the cost of equity and the cost of debt in a discounted cash flow (DCF) analysis when a company has debt.

The rationale behind this lies in the way taxes interact with company financing. For the cost of debt, interest expenses are tax-deductible, which effectively reduces the cost of borrowing. This means that as the tax rate increases, the after-tax cost of debt decreases because the amount of interest paid can lower taxable income. Consequently, this affects the weighted average cost of capital (WACC), which is used to discount future cash flows in DCF.

For the cost of equity, while the tax rate does not directly impact it in the same way, a company's capital structure—especially the proportion of debt—can introduce risk factors that the equity holders consider. If higher tax rates impact the overall cash flows, this can alter investor expectations and hence the required return on equity. Therefore, both financing costs are indirectly affected by tax considerations based on the presence of debt.

Thus, the tax rate's influence on both components of a company's cost of capital is why this answer is accurate in the context of a DCF model involving debt.