Other things remaining the same, an increase in the tax rate on corporate profits will:

Option 1 -> Interest on debt is tax-deductible, so higher tax rates increase the tax shield benefit, making debt relatively cheaper.

Option 2 -> Equity dividends are not tax-deductible, so equity does not benefit from higher tax rates and becomes relatively more expensive compared to debt.

Option 3 -> Higher tax rates reduce the after-tax cost of debt due to tax deductibility of interest (After-tax cost = Cost × (1 - Tax rate)), so there is an impact.

Option 4 -> Higher corporate tax rates reduce after-tax profits; they do not increase profits.

Hence, Option 1 -> When tax rates increase, the tax shield from interest payments becomes more valuable since interest is tax-deductible. This lowers the effective after-tax cost of debt, making debt financing relatively cheaper compared to equity (which receives no tax benefit). -> correct