When personal taxes are included in the MM model, the taxes that stockholders pay on their bond and equity income lowers (or decreases) the benefit created by the tax savings on corporate debt.
Value of Ailing Pharmaceuticals Company:
1). Under MM without taxes, its value will be same as that for an unlevered firm so its value is Vu = 50 million
2). Under MM with corporate taxes, value of levered firm VL = Vu + (debt*corporate tax rate)
= 50 + (35%*20) = 50 + 7 = 57 million
3). Under Miller with corporate tax (Tc), personal tax on equity (Ts) and personal tax on debt (Td):
Value of the firm = Vu + Debt[1-(1-Tc)(1-Ts)/(1-Td)]
= 50 + 20*[ 1 - (1-35%)*(1-8%)/(1-28%)] = 50 + (20*0.1694) = 50 + 3.3889 = 53.39 million
Yes, the preceding information is correct. Personal taxes lower but do not completely eliminate the effect of leverage.
8. M&M and Miller models After Modigliani and Miller's (MM) original no-tax theory, they went on ...