Consider an economy in which there are four groups of people:

The required rate of return after corporate tax on all-equity financed projects is 8 percent. Interest income is taxable at the individual level, but equity income is untaxed at the personal level for all investors. Corporations generate annual EBIT of $145 million in perpetuity. The corporate tax rate is 38 percent.

a. What is the range of possible aggregate debt-to-equity ratios in the economy?

b. What would your answer to (a) be if the corporate tax rate were 27 percent?

TB (%) 45% 35 25 0 Wealth (in $ millions) $450 400 150 475 Group