Reference no: EM131690558

Question - Suppose the corporate tax rate is 35%, and investors pay a tax rate of 20% on income from dividends or capital gains and a tax rate of 38.4% 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 they earn? After paying taxes on the interest, debt holders will receive $___ million.

B. By how much will the firm need to cut its dividend each year to pay this interest expense? The firm will need to cut its dividend by $___ million.

C. By how much will this cut in the dividend each reduce equity holders' annual after-tax income? The dividend cut will reduce equity holders' annual after-tax income by $___ million.

D. How much less will the government receive in total tax revenues each year? The government will receive $___ million less in tax revenues.

E. What is the effective tax advantage of debt τ*? The effective tax advantage of debt is ___%.