G L = gain from leverage

3. (5 points) We showed that with corporate and personal income taxes affect the gain from leverage. Using the variables defined below, answer the following questions. V = value of the levered firm Vy = value of the unlevered firm EBIT = operating earnings before interest and taxes = market value of the debt F = face value of the debt r'o = before tax return on debt ra = return on unlevered equity T = corporate tax rate Td = personal tax rate on interest income Te = effective personal tax rate on equity income (1) Under what condition will G = TD? How can this happen? (2 points) (2) Under what condition will G = 0 ? Discuss what your condition implies for the relative magnitudes of corporate and personal tax rates, if t, td, and Te are all greater than zero. (3 points) 3. (5 points) We showed that with corporate and personal income taxes affect the gain from leverage. Using the variables defined below, answer the following questions. V = value of the levered firm Vy = value of the unlevered firm EBIT = operating earnings before interest and taxes = market value of the debt F = face value of the debt r'o = before tax return on debt ra = return on unlevered equity T = corporate tax rate Td = personal tax rate on interest income Te = effective personal tax rate on equity income (1) Under what condition will G = TD? How can this happen? (2 points) (2) Under what condition will G = 0 ? Discuss what your condition implies for the relative magnitudes of corporate and personal tax rates, if t, td, and Te are all greater than zero. (3 points)