Question
Suppose the corporate tax rate is 21%, and investors pay a tax rate of 20% on income from dividends or capital gains and a tax
Suppose the corporate tax rate is 21%, and investors pay a tax rate of 20% on income from dividends or capital gains and a tax rate of 33% on interest income. Your firm decides to add debt so it will pay an additional $10 million in interest each year. It will pay this interest expense by cutting its dividend.
a. How much will debt holders receive after paying taxes on the interest theyearn?
After paying taxes on theinterest, debt holders will receive $............... million. (Round to two decimalplaces.)
b. By how much will the firm need to cut its dividend each year to pay this interestexpense?
The firm will need to cut its dividend by $.............. million. (Round to two decimalplaces.)
c. By how much will this cut in the dividend reduce equityholders' annualafter-tax income?
The dividend cut will reduce equityholders' annualafter-tax income by $................ million. (Round to two decimalplaces.)
d. How much less will the government receive in total tax revenues eachyear?
The goverment will receive $............. million less in tax revenues. (Round to two decimalplaces.)
e. What is the effective tax advantage of debt tau*?
The effective tax advantage of debt is ...............%. (Round to one decimalplace.)
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