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The CIG Power Corporation expects to report earnings before interest and taxes of $25 million this year. Management has determined that the firm needs $10 million of new capital this year to fund its anticipated capital investments. One alternative is to borrow the funds from a syndicate of banks at a 15 percent rate of interest. Alternatively, CIG could sell $10 million of a new preferred stock that pays annual dividends of $1.4 million. The marginal tax rate for CIG is 40 percent.
a. What will be the "earnings after tax and available for common stockholders" if the money is borrowed?
b. What will be the "earnings after tax and available for common stockholders" if preferred stock is sold?
4. Patriot Industries recently sold its fin fabrication machine for $150,000. The machine originally cost $500,000 and has a current book value of $100,000. Patriot's marginal tax rate is 35 percent for ordinary income and 35 percent for capital gains income.
a. What amount of gain has Patriot received from this transaction?
b. Is this a capital or ordinary gain?
c. How much tax must Patriot pay on this transaction?
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