a) Since the debt is riskless, and both the real and nominal inflation rates are zero, the firm's debt has no in- terest payments. Since only interest payments are deductible, the firm has no...

Can you explain why the inflationary enviroment gives a higher incoem for shareholders in question C.

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Extracted text: a) Since the debt is riskless, and both the real and nominal inflation rates are zero, the firm's debt has no in- terest payments. Since only interest payments are deductible, the firm has no deductions from EBIT. (in € millions) EBIT Interest deductions Taxable income - Тахes - Debt payment Income for shareholders € 125.00 € 200.00 € 0.00 € 200.00 -€ 25.00 |-€ 50.00 b) With 10% inflation, EBIT increases by 10%. Also, the firm pays €5 million in deductible interest next year. (in € millions) EBIT € 220.00 Interest deductions -€ 5.00 (because of inflation, the nominal interest rate becomes 0+10% = 10%. Interest = 10% of 50 million debt Taxable income € 215.00 - Taxes -€ 26.88 - Debt payment Income for shareholders -€ 50.00 € 138.13 c) The income in the inflationary environment is higher, in real terms, by: Differences between the two environment =138.13/1.1-125= € 0.57 Thus, we can conclude that there is a gain from the tax shield generated by higher nominal interest payments.


Extracted text: 14.4 Assume that the real riskless interest rate is zero and the corporate tax rate is 12.5 per cent. TAL Industries can borrow at the riskless interest rate. It will have an inflation-adjusted EBIT next year of €200 million. It would like to borrow €50 million today. Its only deductions will be interest payments (if any). a What are its interest payments, taxable income, tax payments and income left for share- holders in a no-inflation environment? b Suppose there is inflation of 10 per cent per year, but the real interest rate stays at zero. This means that investors now will require a sure payment of €1.10 next year for each €1.00 loaned today. Repeat part a, assuming that EBIT is affected by inflation. Exercises 493 c In which environment is the inflation-adjusted income left for shareholders higher? Why?