Question

1. Given the following: Corporate tax rate 40%; Dividend/Capital Gains tax rate: 15%; Ordinary income tax rate 35%. Our company decides to issue incremental debt in order to increase our interest expense by $25 million annually.

   1. How much will debt holders receive after all applicable taxes are paid?

   2. How much will the company need to reduce its dividend in order to pay the additional interest expense?

   3. How much will the dividend cut reduce shareholder after-tax annual income?

   4. How much more or less will the government receive in tax revenues from our company and its bondholders and shareholders?

   5. What is the effective tax advantage of debt, τ*?

Answer 1

- duides to issue incremental debt in order to Net Amount received by bend holders. since interest on debt is tax deductible for the company, hence Answers! 0 Guiven that corporate Hart rate : 40 %. tax rate a 15% nividend (capital gains Cordinary income tax rate -35°/. Our company increase our interest expense by $ 25 million anually. a company is not to pan required tas on interest. However interest received by the bord holders is the ordinary income for them, this net amount received by them wis net of tax poud as follows: Net amount received s Interest isleme (l-Ordinary tad mate) - $25000.000 (-0.35) = $16250,000 The company need reduce its dividend in order to pay the additional interest expense - Interest income - Corporate Taxe - $25000.000 (1-0.40) = $ 15000,000 © Reduction in after tax annual income of Shareholders. Since dividend received by shareholders are subject to dividend tax @ 159%, thus reduction is affey tax annual income is calculated as follows: - Dividend cut (1. dividend tax rate) $15,000,000 (1-0-15) = $12750,000 .

Government will receive the Hollowing amount. Receive more from Band holders-Interest Income X359% - $25000,000 ¥350/- 5 $8,750,000. Receive Jess from company = $25000, 000XH07- = $10,000,000. Receive less from share holders = $15000, 000X15°/. 6$2250,000

Answer 2

- duides to issue incremental debt in order to Net Amount received by bend holders. since interest on debt is tax deductible for the company, hence Answers! 0 Guiven that corporate Hart rate : 40 %. tax rate a 15% nividend (capital gains Cordinary income tax rate -35°/. Our company increase our interest expense by $ 25 million anually. a company is not to pan required tas on interest. However interest received by the bord holders is the ordinary income for them, this net amount received by them wis net of tax poud as follows: Net amount received s Interest isleme (l-Ordinary tad mate) - $25000.000 (-0.35) = $16250,000 The company need reduce its dividend in order to pay the additional interest expense - Interest income - Corporate Taxe - $25000.000 (1-0.40) = $ 15000,000 © Reduction in after tax annual income of Shareholders. Since dividend received by shareholders are subject to dividend tax @ 159%, thus reduction is affey tax annual income is calculated as follows: - Dividend cut (1. dividend tax rate) $15,000,000 (1-0-15) = $12750,000 .

Government will receive the Hollowing amount. Receive more from Band holders-Interest Income X359% - $25000,000 ¥350/- 5 $8,750,000. Receive Jess from company = $25000, 000XH07- = $10,000,000. Receive less from share holders = $15000, 000X15°/. 6$2250,000