1. Suppose that the IRS claims that the Rollo Corporation is “thinly capitalized”. The IRS characterizes the payments on the corporation’s bonds as dividend payments. Then the Rollo Corporation takes the case to court since this characterization is unfavorable.
a. What are some of the factors the court would examine before disregarding the debt classification?
b. What is one rule of thumb applied by the courts with regard to debt-equity ratio?