Suppose the corporate tax rate is 35%. Consider a firm that earns $2000 before

interest and taxes each year with no risk. The firm's capital expenditures equal

its depreciation expenses each year, and it will have no changes to its net working

capital. The risk-free interest rate is 8%.

a.

Suppose the firm has no debt and pays out its net income as a dividend each

year. What is the value of the firm's equity?

b. Suppose instead the firm makes interest payments of $1300 per year. What is

the value of equity? What is the value of debt?

c.

What is the difference between the total value of the firm with leverage and

without leverage?

d.

To what percentage of the value of the debt is the difference in part (c) equal?