Consider the EBIT of a firm can take 3 different values: 13, 19, and 24 with probabilities 25%, 50%, and 25%, respectively.

a) If the corporate tax rate equals 40% and there are no personal taxes, what is the optimal level of interest payments?

b) Consider, besides the corporate tax of 40%, personal taxes such that equity income is taxed at the 15% rate and debt income is taxed at the 40%. What is the effective tax advantage of debt if the interest payment is 7? 

c) Considering the same taxes as in part b). What is the effective tax advantage of debt if the interest payment is 15? 

d) What is the optimal level of interest payment considering the corporate and personal taxes?

Answer rating: 100% (QA)

SOLUTION a To find the optimal level of interest payments we need to calculate the interest tax shield for each level of EBIT and choose the level of ... View the full answer