1 suppose t e t t d cpn and r d are 0 20 0 50m m

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equity income which helps to explain some of the difference. Most of the difference can be explained by the fact debtholders now pay taxes. Note that even without considering the impact of (1 – α ), we have: (1 – T d )CPN / r d = (1 – 0.85)\$50M / 0.05 = \$850 million. For the corporate tax view, this value would be \$1 billion because debtholders do not pay personal taxes. ANSWER (3): If personal tax rates are equal (T e = T d ), then α = (1 – T e )(1 – T) / (1 – T d ) = (1 – T) = (1 – 0.2) = 0.8 . G L = [1 – α ]D = [1 – α ](1 – T d )CPN / r d = (1 – 0.8)(1 – T d )\$50M / 0.05 = (1 – T d )\$200 million . For the corporate tax view, we have: G L = TD = T(CPN / r d ) = 0.2(\$50M / 0.05) = 0.2(\$1 billion) = \$200 million . Thus, the answer for G L for the corporate tax view is like that for the personal tax except that \$200 million is multiplied by (1 – T d ), which takes into account the situation that debtholders now pay taxes. The similarity in answers results because (1 – α ) reduces to T when T e = T d .
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