Question $2$

In a country, dividends and capital gains are taxed at a rate of $20\%,$ and interest income is taxed at a rate of $50\%.$ The firms in this country are facing a corporate income tax rate of $30\%.$

a$)$ Considering the information regarding corporate and personal taxes, determine whether or not debt financing has tax advantage in this country.

b$)$ Suppose that a new government proposes an increase in the tax rates on dividends and capital gains from $20\%$ to $40\%.$ Under this new tax system, determine whether the firms' use of leverage would increase or decrease. Justify your answer.