Wigdor Manufacturing Is Currently All Equity fiNanced, Had EBIT of £2

question 53

Essay

Wigdor Manufacturing is currently all equity financed, had EBIT of £2 million, and is in the 34% tax bracket.Louis, the company's founder, is the lone shareholder.Assume that all earnings are paid out as dividends.Now consider the fact that Louis must pay personal tax on the firm's cash flow.Louis pays taxes on interest at a rate of 33%, but pays taxes on dividends at a rate of 28%. If the firm were to convert £4 million of equity into debt at a cost of 10%, calculate the total cash flow to Louis after he pays personal taxes.Compare this to Louis' total cash flow after personal taxes if the firm remains unlevered.

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Definitions:

Stereotyping

The act of assigning specific attributes to an individual or group based on perceived characteristics of the group they belong to, often oversimplifying complex diversities.

Deductive Reasoning

A reasoning method where an inference is drawn from the agreement of several assumptions which are typically believed to be accurate.

Halo Effect

A cognitive bias where one's overall impression of a person influences how one feels and thinks about their character or properties.

Creative Thinking

The ability to think in unique, novel, and original ways in order to solve problems or generate new ideas.