Suppose we are at the end of 2019. All cash flows arrive at the end of each year. Firm C

will have EBIT in 2020 of $260 million. Capital expenditures will be $70 million. Depreciation

will also be $70 million. The increase in net working capital, the increase in net

other assets, and operating lease interest will be zero. The marginal corporate tax rate is

and will be 20% in every year. Firm C's WACC at its current capital structure is and will

be 7%. The expected permanent growth rate of Firm C's free cash flow and EBIT is 4%

per year. Amortization will be zero in 2020 and every future year so that EBITA will

equal EBIT.

Currently, Firm C is an all equity firm and has no debt. It could borrow at an interest rate

of 5%. Assume that the marginal personal tax rate for equity income is and will be 30%,

and the marginal personal tax rate for debt (interest) income is and will be 35%.

In a world in which the only deviation from perfect capital markets is the existence of

taxes, should Firm C choose a leverage ratio (D/(D+E)) above 78% at the end of 2019 if

Firm C chooses its leverage ratio to maximize its firm value? Assume that all interest

payments have to be made at the end of each year and the first interest payment would

have to be made at the end of 2020. Assume that any interest expense that cannot be used

to reduce corporate taxes in the year it is paid cannot be used to reduce corporate taxes in

any past or future year either. Ignore the limits on the tax deductibility of interest imposed

by the Tax Cuts and Jobs Act of 2017.