Chapter 15, Problem 27P

PMF, Inc., is equally likely to have EBIT this coming year of $10 million, $15 million, or $20 million. Its corporate tax rate is 35%, and investors pay a 15% tax rate on income from equity and a 35% tax rate on interest income.

1. a. What is the effective tax advantage of debt if PMF has interest expenses of $8 million this coming year?
2. b. What is the effective tax advantage of debt for interest expenses in excess of $20 million? (Ignore carryforwards.)
3. c. What is the expected effective tax advantage of debt for interest expenses between $10 million and $15 million? (Ignore carryforwards.)
4. d. What level of interest expense provides PMF with the greatest tax benefit?