Question
In: Finance
Suppose the corporate tax rate is 35%, and investors pay a personal tax rate of 25%...
Suppose the corporate tax rate is 35%, and investors pay a personal tax rate of 25% on income from dividends or capital gains and a personal tax rate of 32.4% on interest income. Your firm decides to add debt so it will pay an additional $30 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 τ*?
Solutions
jeff jeffy answered 1 year agoRelated Solutions
Suppose the corporate tax rate is 35%, and investors pay a tax rate of 15% on...
Suppose the corporate tax rate is
35%,
and investors pay a tax rate of
15%
on income from dividends or capital gains and a tax rate of
37.3%
on interest income. Your firm decides to add debt so it will pay
an additional
$20
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...
Suppose the corporate tax rate is 38%, and investors pay a tax rate of 15% on...
Suppose the corporate tax rate is 38%, and investors pay a tax
rate of 15% on income from dividends or capital gains and a tax
rate of 30.1% on interest income. Your firm decides to add debt so
it will pay an additional $20 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...
Suppose the corporate tax rate is 40%, investors pay a tax rate of 20% on income...
Suppose the corporate tax rate is 40%, investors pay a tax rate
of 20% on income from dividends or capital gains and a tax rate of
30% on interest income.
Rally, Inc., currently an all-equity
firm, is considering adding permanentdebt through a levered
recapitalization (Rally plans to raise 300 million through debt and
payout the proceeds to shareholders). Interest Rally will be paying
each year is expected to be $15 million. Rally will pay this
interest expense by cutting its...
Suppose the corporate tax rate is 40%, investors pay a tax rate of 20% on income...
Suppose the corporate tax rate is 40%, investors pay a tax rate
of 20% on income from dividends or capital gains and a tax rate of
30% on interest income.
Rally, Inc., currently an all-equity firm, is considering adding
permanent debt through a levered recapitalization (Rally plans to
raise 300 million through debt and payout the proceeds to
shareholders). Interest Rally will be paying each year is expected
to be $15 million. Rally will pay this interest expense by cutting...
Suppose the corporate tax rate is 40%, investors pay a tax rate of 20% on income...
Suppose the corporate tax rate is 40%, investors pay a tax rate
of 20% on income from dividends or capital gains and a tax rate of
30% on interest income.
Rally, Inc., currently an all-equity
firm, is considering adding permanent debt through a levered
recapitalization (Rally plans to raise 300 million through debt and
payout the proceeds to shareholders). Interest Rally will be paying
each year is expected to be $15 million. Rally will pay this
interest expense by cutting...
Suppose the corporate tax rate is 35%. Consider a firm that earns $2,000 in earnings before...
Suppose the corporate tax rate is 35%. Consider a firm that
earns $2,000 in earnings before interest and taxes each year with
no risk. The firm's capital expenditures equal its depreciation
expenses each year, and it will have no changes to its net working
capital. The risk-free interest rate is 7%.
a. Suppose the firm has no debt and pays out its net income as a
dividend each year. What is the value of the firm's equity?
b. Suppose instead...
Refer to Problem 1. Suppose investors are subject to 20% personal tax rate on dividend income...
Refer to Problem 1. Suppose investors are subject to 20%
personal tax rate on dividend income and personal 40% tax rate on
interest income. Based on this information and the information in
Problem 1: a. What will be the market value of the firm’s equity
after the change in its capital structure? b. What will be the
share price after the change in firm’s capital structure? c. What
will be the firm’s WACC after the change in its capital
structure?...
Assume a corporate tax rate is 40% and an individual tax rate of 25%. Perryton Corp....
Assume a corporate tax rate is 40% and an individual tax rate of
25%. Perryton Corp. earned $12,000,000 before income taxes during
the year. Perryton kept $5,000,000 of after-tax profits inside the
company to support future growth. How much total tax would have
been paid to Internal Revue Service (IRS) by all related
parties?
Given the following: Corporate tax rate 40%; Dividend/Capital Gains tax rate: 15%; Ordinary income tax rate 35%. Our company...
Given the following: Corporate tax rate 40%;
Dividend/Capital Gains tax rate: 15%; Ordinary income
tax rate 35%. Our company decides to issue incremental
debt in order to increase our interest expense by $25 million
annually.
How much will debt holders receive after all applicable taxes
are paid?
How much will the company need to reduce its dividend in order
to pay the additional interest expense?
How much will the dividend cut reduce shareholder after-tax
annual income?
How much more or less will the...
The U.S. government has decided to decrease the corporate tax rate from 35% to 20% (for...
The U.S. government has decided to decrease the corporate tax
rate from 35% to 20% (for the record, I originally wrote this
problem long before this actually happened). You have been tasked
with re-estimating the remaining PV of a project’s cash flows. The
project will operate for the next 4 years before shutting down. It
will produce yearly revenue of $40k with yearly operating costs of
$20k. The project utilizes some heavy machinery which has a current
book value of...
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