Suppose the corporate tax rate is 40%. Consider a firm that earns $1000 before interest and taxes each year with no risk. The risk free rate is 5%.
A) Suppose the firm has no debt and pays out its net income as a dividend each year. What is the value of the unlevered firm?
B) Suppose instead the firm makes interest payments of $500 per year, i.e adds debt. What is the difference between the total value of the firm with leverage and without leverage?
Please show your work for both A and B