Question: Suppose the corporate tax rate is 40%. Consider a firm that earns $4,500 before interest and taxes each year with no risk. Thefirm's capital expenditures

Suppose the corporate tax rate is 40%. Consider a firm that earns $4,500 before interest and taxes each year with no risk. Thefirm's capital expenditures equal its depreciation expenses eachyear, and it will have no changes to its net working capital. Therisk-free interest rate is 8%.

a. Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of thefirm's equity?

b. Suppose instead the firm makes interest payments of $2,800 per year. What is the value ofequity? What is the value ofdebt?

c. What is the difference between the total value of the firm with leverage and withoutleverage?

d. The difference in (c) is equal to what percentage of the value of thedebt?

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