Question
PMF, Inc., can deduct interest expenses next year up to 30% of EBIT. This limit is equally likely to be $2 million, $11 million, or
PMF, Inc., can deduct interest expenses next year up to 30% of EBIT. This limit is equally likely to be
$2
million,
$11
million, or
$20
million. Its corporate tax rate is
38%,
and investors pay a
30%
tax rate on income from equity and a
35%
tax rate on interest income.
a. What is the effective tax advantage of debt if PMF has interest expenses of
$2
million this coming year?
b. What is the effective tax advantage of debt for interest expenses in excess of
$20
million? (Ignore carryforwards).
c. What is the expected effective tax advantage of debt for interest expenses between
$2
million and
$11
million? (Ignore carryforwards).
d. What level of interest expense provides PMF with the greatest tax benefit?
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