Page 18 of 19 Capital structure and the cost of capital (10 marks) Hip-E Industries anticipates a perpetual pretax earnings stream of $250,000 and faces a 35% corporate tax rate. Investors discount the earnings stream after corporate taxes at 15%. The personal tax rate on equity distributions is 30% and the personal tax rate on interest is 45%. Hip-E currently has an all-equity capital structure but is considering borrowing $100,000 at 8%. a. What is the value of the all-equity Hip-E Industries? Hint: This value will not be affected by the personal tax rates. (4 marks) What is the value of Hip-E Industries if it borrows the $100,000, taking into account corporate tax rate (Tc), personal tax rate on equity income (Ts), and personal tax rate on interest income (T)? (4 marks) Hint: The total combined tax rate is calculated as: (1-Tc) x (1-Ts)/(1-Tb). What is the net gain from financial leverage? Should Hip-E Industries go ahead and borrow $100,000? (2 marks)