Answer 1:

If Congress reduced the tax rate on corporate income and increased the personal tax rate on dividends
and capital gains, it would increase companies net after tax income, since they would be paying less in
taxes. Increasing or decreasing the personal tax rate on dividends and capital gains has no effect on
companies, as they don't get any tax benefit from the dividends that they pay to shareholders.
An Increase in the personal tax rate leads to both stocks and bond being less attractive to investors
because it raises the tax paid on dividend and interest income. Changes in personal tax rates will have
differing effects, depending on what portion of an investment’s total return is expected in the form of
interest or dividends versus capital gain. For example, higher personal tax rate has a greater impact on
bondholders because more of their return will be taxed sooner at the new higher rate. An increase in
personal tax rate will cause some investors to shift from bonds to stocks because of the attractiveness of
capital gains tax deferrals.
This raises the cost of debt relative to equity. In addition, a lower corporate tax rate reduces the advantage of
debt by reducing the benefit of a corporation’s interest deduction that discourages the use of debt.
Consequently, the net result would be for firm’s to use more equity and less debt in their capital structures.

Answer 2:
Basic finance theory suggests that investment and financing decisions can be made independent of
each other, and capital budgeting principles suggest that the firm should select the investment option
(highly automated or less automated process) which has the highest net present value (NPV) or the
lowest present value outflow if it is solely a service investment. It may be useful, however, for the
firm to think about these decisions jointly and to think in terms of leverage and risk concepts when
evaluating which process to adopt. The highly automated process would require huge capital and
require new equipment and ongoing utilities expenses to operate this equipment, so fixed operating
costs would be high. The less automated process, on the other hand, would be labour intensive and
involve high variable (primarily staffing) costs. Thus, the highly automated process would increase
the firm’s operating leverage and its business risk, whereas the less automated process would have
lower operating leverage (as staff numbers or working hours could be modified in line with sales
movements) and provide the firm will lower business risk.
As operating leverage and financial leverage are interrelated. The highly automated process would
increase the firm’s operating leverage; thus, its optimal capital structure would call for less debt. On
the other hand, the less automated process would call for less operating leverage; thus, the firm’s
optimal capital structure would call for more debt.