Suppose the corporate tax rate is 40%, and investors pay a tax rate of 15% on income

Question:

Suppose the corporate tax rate is 40%, and investors pay a tax rate of 15% on income from dividends or capital gains and a tax rate of 33.3% on interest income. Your firm decides to add debt so it will pay an additional $15 million in interest each year. It will pay this interest expense by cutting its dividend.
a.
How much will debt holders receive after paying taxes on the interest they earn?
b. By how much will the firm need to cut its dividend each year to pay this interest expense?
c. By how much will this cut in the dividend reduce equity holders’ annual after-tax income?
d. How much less will the government receive in total tax revenues each year?
e. What is the effective tax advantage of debt t*?

Dividend
A dividend is a distribution of a portion of company’s earnings, decided and managed by the company’s board of directors, and paid to the shareholders. Dividends are given on the shares. It is a token reward paid to the shareholders for their...
Fantastic news! We've located the answer you've been seeking!

Step by Step Answer:

Related Book For  answer-question

Corporate Finance

ISBN: 978-0133097894

3rd edition

Authors: Jonathan Berk and Peter DeMarzo

Question Posted: