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?