Given the following information, leverage will add how much value to the unlevered firm per dollar of debt? Corporate tax rate: 30%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from stocks: 0%
A) $0.125.
B) $0.472.
C) $0.528.
D) $0.825.

Question

Quizplus · Accepted Answer

The value added to the unlevered firm per dollar of debt due to leverage, according to the Modigliani-Miller Proposition II with taxes, can be calculated considering the corporate tax shield and the personal taxes on income from bonds and stocks. The formula to calculate the tax shield benefit is: (Corporate Tax Rate) * (1 - Personal Tax Rate on Bonds) / (1 - Personal Tax Rate on Stocks). Given the corporate tax rate is 30% (0.30), the personal tax rate on income from bonds is 20% (0.20), and the personal tax rate on income from stocks is 0% (0.00), the calculation is: 0.30 * (1 - 0.20) = 0.30 * 0.80 = 0.24. However, since the personal tax rate on income from stocks is 0%, it simplifies the calculation to just considering the corporate tax shield, which is 0.30. The discrepancy in the calculation arises from the interpretation of how personal taxes affect the overall value added by leverage. Given the choices provided and the standard approach to calculating the value added by leverage in a world with taxes but without specifying the adjustment for personal taxes in the options, the closest answer reflecting a basic tax shield benefit would be $0.30 per dollar of debt, which is not listed. Therefore, based on the options provided and considering a potential misunderstanding in the calculation process, the correct choice would be to re-evaluate how the value is derived, typically leading to an answer that reflects the corporate tax shield directly, but since none of the options accurately reflect this and considering a mistake in my explanation, the correct methodology involves calculating the net benefit considering both corporate and personal taxes, which was intended to be demonstrated but was inaccurately concluded. The correct calculation should factor in the differential tax benefits considering the corporate tax rate and the effective personal tax rates on bond income versus stock income, leading to a nuanced interpretation of the tax shield's value.

Given the Following Information, Leverage Will Add How Much Value