Consider two firms, Go Debt corporation and No Debt corporation. ...

[sabina]

Consider two firms, Go Debt corporation and No Debt corporation. Both firms are expected to have earnings before interest and taxes of 100,000 during the coming year.
 
  In addition, Go Debt is expected to incur 40,000 in interest expenses as a result of its borrowings whereas No Debt will incur no interest expense because it does not use debt financing. However, No Debt will have to pay stockholders 40,000 in dividend income. Both firms are in the 40 percent tax bracket. Calculate the Earnings after tax for both firms. Which firm has the higher after-tax earnings? Which firm appears to have the higher cash flow? How do you account for the difference?

Question 2

Using the risk-adjusted discount rate method of project evaluation, the NPV for Project N is ________. (See Table 11.8)
 
  A) 166,132
  B) 122,970
  C) 85,732
  D) 600,000

[blfontai]

Answer to Question 1

Go Debt has lower earnings after taxes compared to No Debt. However, from a cash outflow perspective, Go Debt paid out a total of only 64,000 (40,000 in interest expenses plus 24,000 in taxes) while No debt paid out a total of 80,000 (40,000 in taxes and 40,000 in dividends). The difference between the two is 16,000 which is exactly the difference in taxes paid between the two firms (24,000 compared to 40,000). This difference results from the fact that interest expense is a tax deductible expense.

Answer to Question 2

C

[sabina]

TY

[blfontai]

Happy to Help