An important topic in Corporate Finance is to study how taxes affect the capital structure of the firm. Since interest payments are universally tax-deductible, we explore the question of whether corporate taxes encourage debt finance. The table below shows data on corporate income tax rates for a cross section of 30 countries in 2004. The data suggests that countries with higher effective (as well as statutory) tax rates use sharply more debt. This result is consistent with most theories of optimal capital structure in the corporate finance literature.

COUNTRY DEBT_EQUITY_RATIO TAX_RATE Argentina 190.25 23.53565 Australia 140.7 21.96434 Austria 248.05 20.8581 Click to download full dataset Excel file.

Question 1: Find the sample regression equation for the model:

left parenthesis D E right parenthesis subscript i equals beta subscript 0 plus beta subscript 1 T A X subscript i plus u subscript i

where left parenthesis D E right parenthesis subscript i is the debt-equity ratio for an average mid-size domestic firm in country i and T A X subscript i is the 1-year effective tax rate in country i.

COUNTRY DEBT_EQUITY_RATIO TAX_RATE Argentina 190.25 23.53565 Australia 140.7 21.96434 Austria 248.05 20.8581 Belgium 123.05 16.70624 Brazil 104.02 15.48972 Canada 99.86 21.77546 Chile 101.28 15.09129 China 89.08 15.74542 Colombia 58.16 24.28119 Czech Republic 31.8 9.291983 Denmark 73.13 21.93621 Egypt 96.12 17.07187 Finland 25.01 16.29939 France 237.04 14.05677 Germany 252.94 23.50408 Greece 161.68 19.78156 Hong Kong, China 41.35 0 Hungary 62.09 9.481503 India 67.41 20.27757 Indonesia 80.48 20.84461 Israel 101.78 25.72076 Italy 261.3 23.81908 Japan 200.27 28.65799 Korea 115.35 14.94203 Malaysia 98.22 10.50019 Mexico 65.94 22.20908 Morocco 37.23 17.74411 Netherlands 213.82 25.61538 New Zealand 106.39 26.44177 Norway 116.48 18.50233

An important topic in Corporate Finance is to study how taxes affect the capital structure of the firm. Since interest payments are universally tax-deductible, we explore the question of whether corporate taxes encourage debt finance. The table below shows data on corporate income tax rates for a cross section of 30 countries in 2004. The data suggests that countries with higher effective (as well as statutory) tax rates use sharply more debt. This result is consistent with most theories of optimal capital structure in the corporate finance literature.

COUNTRY	DEBT_EQUITY_RATIO	TAX_RATE
Argentina	190.25	23.53565
Australia	140.7	21.96434
Austria	248.05	20.8581

What is the predicted debt-equity ratio for mid-size domestic firm with a corporate tax rate of 15%?

What are the values of alpha and beta?

Calculate the value of the appropriate test statistic.

At the 5% significance level, what is the conclusion to the test? Is an investment in C stock riskier than the market?

Calculate the value of the appropriate test statistic

At the 5% significance level, what is the conclusion to the test? Is there evidence of "abnormal returns"?