Cornhusker Corporation plans to raise $10 million cash on January 1, 2014, by issuing either bonds payable (8% interest rate) or cumulative preferred stock (8% dividend rate). How would the annual interest amount on the bonds or annual preferred dividend amount (if paid) affect the net income for the year ended December 31, 2014?

Question

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If Cornhusker Corporation issues bonds, the annual interest on the bonds would be deductible for income tax purposes and would reduce the company's taxable income, thus reducing its net income. On the other hand, if the company issues preferred stock, the annual preferred dividends are not tax deductible and would not affect the company's taxable income. However, the payment of preferred dividends would be deducted from the company's net income, thus reducing it. Therefore, net income would be reduced by the annual interest on the bonds but not by the annual preferred stock dividends.

Cornhusker Corporation Plans to Raise $10 Million Cash on January