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One of the main objectives of any firm is to arrange its capital structure to minimize...

One of the main objectives of any firm is to arrange its capital structure to minimize taxable income for both the company and the shareholders. Because companies enjoy a tax deduction for interest expense there often can be an overall financial advantage to debt financing. Under the recent tax law overhaul, the top marginal rate personal income tax rate is 37%, income for corporations is taxed at a flat 21 %, and the prevailing rate on equity income (dividends and capital gains) is 15%. Given the above, calculate the Relative Tax Advantage of debt? Calculate to two decimal places A. 0.67 B. 0.94 C. 1.47 D. 1.56

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Answer #1

Marginal personal tax rate = Personal tax rate on interest income = Tp = 37%

Corporate tax rate = Tc = 21%

Tax rate on Equity income = TpE = 15%

We know that

Relative tax advantage of debt = 63% / 67.15% = 0.93819 =0.94 (rounded to two places of decimal)

Hence Answer is B. 0.94

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