Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

a. You work for a firm that is very good at sheltering income from corporate taxes. As a result, your firm as a fairly low

a. You work for a firm that is very good at sheltering income from corporate taxes. As a result, your firm as a fairly low effective corporate tax rate of 10 percent. The debt holders of your firm face a marginal tax rate on interest income (from debt payments) of 20 percent. Your shareholders face a tax rate on capital gains and distributions to equity of 10 percent. In the event of a bankruptcy, your bankruptcy costs will be about 5 percent of the value of the assets that remain. Should you have a lot, a little, or no debt in your capital structure? Explain why.

b. When (under what conditions) might managers, working on behalf of shareholders, take on risky but negative NPV projects?

c. The tax bill passed by the US Congress a few years ago lowered corporate tax rate on US firms to 20%. The tax bill also did very little to close a number of loop-holes firms use to reduce their taxes. Based on this reduction in the effective tax rates US firms pay, what does static trade-off imply with respect to changes, relative to pre-tax-bill levels, in (a) the optimal amount of debt firms will have in their capital structure, (b) the values of firms (if nothing else other than the tax rate changes), and (c) the likelihood of future bankruptcies. Why?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Foundations of Financial Management

Authors: Stanley Block, Geoffrey Hirt, Bartley Danielsen

16th edition

125927716X, 978-1259687969, 1259687961, 978-1259277160

More Books

Students also viewed these Finance questions