Tailor​ Johnson, a U.S. maker of fine​ menswear, has a subsidiary in Ethiopia. This​ year, the subsidiary reported and repatriated earnings before interest and taxes​ (EBIT) of 228 million Ethiopian birrs. The current exchange rate is 7.0669 ​birrs/dollar or Upper S equals $ 0.1415 divided by birr. The Ethiopian tax rate on this activity is 22 %. U.S. tax law requires Tailor Johnson to pay taxes on the Ethiopian earnings at the same rate as on profits earned in the United​ States, which is currently 42 %. ​However, the United States gives a full tax credit for foreign taxes paid up to the amount of the U.S. tax liability. What is Tailor​ Johnson’s U.S. tax liability on its Ethiopian​ subsidiary?

Petron​ Corporation’s management team is meeting to decide on a new corporate strategy. There are four​ options, each with a different probability of success and total firm value in the event of​ success, as shown​ here: LOADING…. Assume that for each​ strategy, firm value is zero in the event of failure.​ Also, suppose Petron Corp. must pay a 25 % tax rate on the amount of the final payoff that is paid to equity holders. It pays no tax on payments​ to, or capital raised​ from, debt holders.

a. Which strategy will Petron choose with no​ debt? Which will it choose with a face value of $ 10 ​million, $ 32 ​million, or $ 54 million in​ debt? (Assume management maximizes the value of​ equity, and in the case of​ ties, will choose the safer​ strategy.)

b. Given your answer to ​(a​), show that the total combined value of​ Petron’s equity and debt is maximized with a face value of $ 54 million in debt.

c. Show that if Petron has $ 32 million in debt​ outstanding, shareholders can gain by increasing the face value of debt to $ 54 ​million, even though this will reduce the total value of the firm.

d. Show that if Petron has $ 54 million in debt​ outstanding, shareholders will lose by buying back debt to reduce the face value of debt to $ 32 ​million, even though that will increase the total value of the firm.