Moss Inc. is considering issuing $1,000,000 worth of perpetual bonds yielding $60,000 interest per year. Moss Inc. currently has no debt outstanding and will use the bond proceeds to repurchase equity. Moss Inc. has 100% dividend payout ratio and EBIT is $2,000,00 per year forever. Corporate tax rate is 60%.

a. If the personal tax rate is 30%, which plan (all equity or debt + equity) offers the investors the highest cash flows? Why?

b. If the shareholders require a 15% return before personal taxes, what is the value of the firm under each plan? (Do not ignore personal taxes).

c. Suppose Ts=25% and Tb=35%. What are the investors' cash flows under each plan? Repeat part (b).

Answer rating: 100% (QA)

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