Smith Manufacturing is currently all equity financed, had EBIT of £2million, and is in the 34% tax bracket. John, the company's founder, is the lone shareholder. Assume that all earnings are paid out in dividends. Now consider the fact that John must pay personal tax on the dividends he will receive. John pays taxes on interest at a rate of 33% but pays taxes on the dividends at a rate of 28%. If the firm were to convert £4million of equity into debt at an intetest rate of 10% and John holds all the debt, calculate the total cash flow to John after he pays personal taxes. Compare this to John's total cash flow after personal taxes if the firm remains unlevered. What is the change in John's cash flows after personal taxes if the firm becomes levered. a. -£190,080 b. £77,920 c. £150,220 d. £0 e. none of the above
Smith Manufacturing is currently all equity financed, had EBIT of £2million, and is in the 34% tax bracket. John, the company's founder, is the lone shareholder. Assume that all earnings are paid out in dividends. Now consider the fact that John must pay personal tax on the dividends he will receive. John pays taxes on interest at a rate of 33% but pays taxes on the dividends at a rate of 28%. If the firm were to convert £4million of equity into debt at an intetest rate of 10% and John holds all the debt, calculate the total cash flow to John after he pays personal taxes. Compare this to John's total cash flow after personal taxes if the firm remains unlevered. What is the change in John's cash flows after personal taxes if the firm becomes levered.
a. -£190,080
b. £77,920
c. £150,220
d. £0
e. none of the above
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