The CFO of Shalit Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?

Question

Quizplus · Accepted Answer

EBy paying off some of its outstanding bonds with the proceeds from issuing new common stock, the company reduces its interest expense. Since interest expense is deductible, a reduction in interest expense would lead to higher taxable income, assuming EBIT and the tax rate remain constant. Consequently, the company would have to pay more in taxes, not less, making E incorrect. However, with lower interest expenses, the company's net income would increase, making D correct. Choices A, B, and C are incorrect because taxable income would actually increase (not fall), interest expense would decrease (not remain constant), and the company would have more common equity (not less) after issuing new stock and using the proceeds to pay off debt.

The CFO of Shalit Industries Plans to Have the Company