Chapter 16 Appendix Questions

Chapter 16 Appendix Questions - The corporate tax rate is...

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The Miller Model and the Graduated Income Tax 16.17 Consider an economy with three investor groups. The personal tax rates on interest income are 10%, 20%, and 40%, respectively, for these three groups. The corporate tax rate is 35%, and the effective tax rate on equity distributions is zero. The after-tax required rate of return on all-equity financed projects is 11%. a. What is the equilibrium interest rate? b. For this interest rate, will each of the three groups prefer debt or equity? c. If Firm A has earnings before interest and taxes (EBIT) of $1 million in perpetuity, what is its value? Does the firm’s value vary with different capital structure choices? 16.18 Assume that there are three groups of investors with the following tax rates on interest income: The after-corporate tax required rate of return on all-equity financed projects is 8.1%. The only types of securities available are common stock and corporate bonds. Capital gains and dividends are untaxed at the personal level. Corporate earnings before interest and taxes (EBIT) total $85 million per year in perpetuity.
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Unformatted text preview: The corporate tax rate is 35%. Assume all debt is risk-free. a. What is the equilibrium interest rate? b. In equilibrium, will each group invest in debt or equity? c. What is the market value of all companies? d. What is the total tax bill? 16.19 Consider an economy in which there are four groups of people: The after-corporate tax required rate of return on all-equity financed projects is 6%. Interest income is taxable at the individual level, but equity income is untaxed at the personal level for all investors. Corporations generate annual earnings before interest and taxes (EBIT) of $150 million in perpetuity. The corporate tax rate is 40%. a. What is the range of possible aggregate debt-equity ratios in the economy? b. What would your answer to part a be if the corporate tax rate were 30%? Group Investable Funds T B (%) A $357.1 million 50 B $220 million 32.5 C $105 million 10 Group T B (%) Wealth ($ millions) L 50 500 M 40 300 N 20 200 O 500...
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