. a) Vita plc has currently no debt in its capital structure, and it is valued at 250 million. The return on the unlevered equity is 15%. The company has decided to modify its capital structure to enjoy the tax benefits of debt, by issuing 50 million of perpetual debt and using the proceeds to repurchase equity. The company has been told that any borrowings made by them will attract a rate of 7%. The tax rate is 35%.

i) What are the firms earnings before interest and taxes? (Assume that earnings are cash flows.) (5 marks)

ii) What is the return on equity after the change in the firms capital structure? (7 marks)

iii) Now assume that there is personal tax on interest income and equity distribution. The personal tax rate on interest income is 40%. What would the personal tax rate on equity distribution have to be to make the tax advantage of debt equal to zero? (7 marks)

AND b) The shareholders of a levered firm will never want the firm to invest in a negative net present value project. Do you agree or disagree with this statement? Explain. (7 marks)