Suppose that River Cruises, which currently is all-equity-financed, issues $250,000 of debt and uses the proceeds to

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Suppose that River Cruises, which currently is all-equity-financed, issues $250,000 of debt and uses the proceeds to repurchase 25,000 shares. Assume that the firm pays no taxes and that debt finance has no impact on its market value.

Now suppose that the corporate tax is Tc = .35. Demonstrate that when River Cruises borrows the $250,000, the combined after-tax income of its debtholders and equityholders increases (compared to all-equity financing) by 35% of the firm's interest expense regardless of the state of the economy.

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Fundamentals of Corporate Finance

ISBN: 978-0078034640

7th edition

Authors: Richard Brealey, Stewart Myers, Alan Marcus

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