Given the following information, leverage will add how much value to the unlevered ﬁrm per pound of debt?
Corporate tax rate: 40%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from shares: 30%
A)£-0.475
B)£0.475
C)£0.525
D)£0.633
E)None of the above.

Question

Quizplus · Accepted Answer

The value added to the unlevered firm per pound of debt can be calculated using the Modigliani-Miller Proposition II with taxes. The formula to calculate the tax shield is: (Corporate Tax Rate - Personal Tax Rate on Bonds) * Amount of Debt. Given the corporate tax rate is 40% and the personal tax rate on income from bonds is 20%, the tax shield per pound of debt is (0.40 - 0.20) = 0.20 or 20%. Therefore, for every pound of debt, £0.20 is added to the value of the firm. However, this does not directly match any of the provided options, suggesting a need for a more nuanced calculation considering the differential tax rates on income from bonds and shares. The correct calculation involves understanding that the tax advantage of debt is not only the corporate tax shield but also needs to account for the personal taxes on bond and equity income. The given options do not directly reflect a straightforward calculation based on the provided tax rates, suggesting a more complex interpretation or a potential error in the question's assumptions or the provided options. Given the information and typical calculations, none of the options directly align with the basic tax shield calculation, but option B (£0.475) is chosen based on the assumption that the question intends for a deeper analysis or contains a typographical error in the calculation or presentation of options.

Given the Following Information, Leverage Will Add How Much Value