Tucker Enterprises has $100000 worth of debt financing and $200000 in equity financing. This year it paid $8000 in interest on its debt and paid $8000 in dividends to shareholders. Its tax rate is 25 percent. What does this suggest?
A) The dividend payment will increase both taxes and retained earnings.
B) Interest payments will result in a $2000 reduction in its taxes.
C) Neither interest nor dividends will affect the company's taxes because they are both after-tax expenses.
D) The dividend payments will result in an $8000 reduction in its taxes.

Question

Quizplus · Accepted Answer

Interest payments are tax deductible, which means they reduce the company's taxable income. Therefore, the company will save 25% (its tax rate) of the interest payment of $8000 resulting in a $2000 tax reduction. Dividend payments, on the other hand, are not tax deductible and are paid with after-tax dollars, so they do not have any impact on reducing the taxes.

Tucker Enterprises Has $100000 Worth of Debt Financing and $200000