After Modigliani and Miller$$s $($MM$)$ original no$-$tax theory, they went on to develop another theory that included corporate taxes. Subsequently, Miller developed another theory that included the effects of both corporate and personal taxes.

Complete the following sentence based on your understanding of the MM Model with Corporate Taxes:

When personal taxes are included in the MM model, the taxes that stockholders pay on their bond and equity income the benefit created by the tax savings on corporate debt.

Carrot Drug Company has no debt, and its value is $$500\mathrm{.}0$ million. Ailing Pharmaceuticals Co$.$ is otherwise identical but levered with $$200\mathrm{.}000$ million in debt. Under the different models, what is the approximate value of Ailing Pharmaceuticals Co$.$ if its corporate tax rate is $26\%,$ the personal tax rate on equity is $8\%,$ and the personal tax rate on debt is $28\%?$

Model

Ailing Pharmaceuticals Co$.$ Value

$($Millions of dollars$)$

MM without tax $$500\mathrm{.}0$

MM with corporate taxes

Miller with corporate and personal taxes

Consider the following information:

Adding personal taxes to the model lowers, but does not eliminate, the benefit from corporate debt. In the United States, taxes on capital gains are lower than on ordinary income and can be deferred. The effective rate on stock income is normally less than that on bond income, and although the personal tax on debt will lower the gain from corporate debt, it is not usually enough to eliminate it$.$ Therefore, there is still a gain from leverage using Miller$$s model, as well as the MM model with corporate tax.

Is the preceding information correct?

No

Yes