Corporation A decides to borrow $1,000,000 and use the money to buy back $1,000,000 of its common stock.The corporation pays 6% interest on its borrowed funds which exactly equals the amount of the dividend it used to pay on the common stock it repurchased.Therefore,
A) Corporation A's operating income will decrease due to higher interest expense.
B) Corporation A's net income will increase due to the tax deductibility of interest expense.
C) Corporation A will have no change in its operating income since the interest expense exactly offsets the prior dividend payment.
D) Corporation A's gross profit will decrease.

Question

Quizplus · Accepted Answer

Interest expense is tax-deductible, which can reduce the corporation's taxable income and thus increase its net income, unlike dividends which are paid from after-tax income.

Corporation a Decides to Borrow $1,000,000 and Use the Money