Evaluate the impact of the debt and the payment of interest in Corporacin Debt and the Corporation of NO DEBT. Both companies are expected to have earnings before interest and taxes of $ 200,000 during the next year. In addition, the DEBT Corporation is expected to incur interest expenses of $ 800,000 as a result of its indebtedness, while the NO DEBT Corporation will not incur any interest expense because it does not use debt financing. However, NO DEBT will have to pay the shareholders $ 80,000 for dividends. Both firms are in the line of payment of contributions of 40 percent.

a. Calculate the after-tax earnings for both firms. (Use the format that appears on page 44 of the textbook).

Format from page 44 below:

Debt Co. No-Debt Co.

Earnings before interest and taxes $ 200,000 $ 200,000

Less: Interest expenses $ 30,000 $ 0

Profit before taxes $ 170,000 $ 200,000

Less: Taxes (40%) $ 68,000 $80,000

Profits after taxes $ 102,000 $ 120,000

After-tax profit difference $ 18,000

b. Which of the firms has the highest after-tax income?

c. Which of the firms would have the greatest cash flow?

d. How is the difference explained?