The EXES Company is assessing its present capital structure and that structures implications for the welfare of its investors. EXES is currently financed entirely with common stock, of which 1,000 shares are outstanding. Given the risk of the underlying cash flows (EBIT) generated by EXES, investors currently require a 20-percent return on the EXES common stock. The company pays out all earnings as dividends to common stockholders. EXES expects that for each year in the future operating income will be $1,000, $2,000, or $4,200 with respective probabilities of 0.1, 0.4, and 0.5. EXES is contemplating issuing $7,500 in bonds and using the proceeds to repurchase shares.

1. Suppose that the corporate tax rate is 40 percent and all personal income tax rates are zero. Calculate the value of the firm with and without the leverage.
2. Suppose that the corporate tax rate is 40 percent, the personal tax rate on interest income is 40 percent, and the effective tax rate on equity income (earnings) is zero. Calculate the value of the firm with and without leverage.