Company A and Company B are identical in all regards except that during 2016 Company A borrowed $40,000 at an interest rate of 10%.In contrast,Company B obtained financing by acquiring $40,000 from sale of common stock.Company B agreed to pay a $4,000 cash dividend each year.Both companies are in a 30% tax bracket.Which company would show the greater retained earnings at the end of 2016,and by what amount?
A)Company A's retained earnings would be higher by $4,000.
B)Company B's retained earnings would be higher by $2,800.
C)Company A's retained earnings would be higher by $1,200.
D)Both would show the same retained earnings.

Question

Quizplus · Accepted Answer

Company A pays $4,000 in interest, which is tax-deductible, reducing taxable income by $4,000 and saving $1,200 in taxes (30% of $4,000). Company B pays a $4,000 dividend, which is not tax-deductible. Therefore, Company A's retained earnings are higher by $1,200.

Company a and Company B Are Identical in All Regards