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

Question

Quizplus · Accepted Answer

The correct answer is B. The value of the unlevered firm will increase by $0.475 per dollar of debt. This is because the interest expense on the debt is tax-deductible for the corporation, which reduces the corporation's tax liability. The personal tax rate on income from bonds is lower than the personal tax rate on income from stocks, so the after-tax return to bondholders is higher than the after-tax return to stockholders. This makes the firm more valuable to bondholders and less valuable to stockholders, which increases the value of the firm overall.

Given the Following Information, Leverage Will Add How Much Value