C&J Enterprises is an all-equity firm that is considering issuing $13.5 million of perpetual debt. The interest rate is 10%. The firm will use the proceeds of the bond sale to repurchase equity. The firm distributes all earnings available to stockholders immediately as dividends. The firm will generate $3 million of earnings before interest and taxes (EBIT) every year into perpetuity. The firm is subject to a corporate tax rate of 40%. Suppose the personal tax rate on interest income is 55%, and the personal tax rate on equity income is 20%.

a. What is the annual after-tax cash flow to equity holders under each plan?

	Unlevered	Levered
EBIT	$3 million	$3 million
Interest	$0 million	$1.35 million =$13.5 m*0.1
EBT	$3 million	$1.65 million
Corporate Taxes	$1.2 million	$0.66 million
Net Income	$1.8 million	$0.99 million

b. What is the annual after-tax cash flow to debt holders under each plan?

c. Does debt still have an advantage over equity in this case, and why?