First bullet blank 1: dividends, interest

First bullet blank 2: debt, equity

Second bullet blank 1: debt, equity

Second bullet blank 2: debt, equity

Consider the case of Yellow Dragon. Foodstutfs, Inc.: At the beginning of the year, Yellow Dragon Foodstuffs, Inc. had an unlevered value of $9,000,000. It pays federal and state taxes at the marginal rate of 40%, and currently has $3,000,000 in debt capital in its copital structure. According to MM Proposition I with taxes, Yellow Dragon Foodstuffs is allowed to recognize a tax shield of and the levered value of the firm is $12,000,000. $10,200,000.$7,800,000 $6,000,000, In 1977, Merton Miller addod to the discussion regarding the effect of taxes on a firm's value by including the elfect of personal income taxes. He was interested in how the presence of individual income taxes would affect business's use of debt financing, and developed the following model for the value of a levered firm: VL=Vu+D[1(1Ta)(1Ti)(1Ti) where Te,Tw and Ti represent the tax rates imposed on corporate income, personal income from equity investments, and personal income from debt investments, respectively. A bosic premise of Miller's work, under the current US Tax Code, is that investors are willing to occapt a pre-tax return on equity investments than on bond investments because tax rates imposed on bond investments are lower than those imposed on equity investments. equity investments are lower than those imposed on bond investrnents. The result of Miller's work is the conclusion that the US Tax Code produces two competing pressures that affect a business's use of leverage. Thes two conflicting effects are - the deductibility of -Which creates a tax shield-favors the use of financing in a firm's copital structure: - the preferential tax treatment of income (dividends and capital gains) favors the use of financing