Company A and Company B are identical in all regards except that during 2013 Company A borrowed $20,000 at an interest rate of 10%. In contrast, Company B obtained financing by acquiring $20,000 from sale of common stock. Company B agreed to pay a $2,000 cash dividend each year. Both companies are in a 30% tax bracket. Which company would show the greater retained earnings at the end of 2013, and by what amount?

Question

Quizplus · Accepted Answer

$20,000 x 10% = $2,000 interest expense; $2,000 x 30% = $600 tax savings from debt financing. The $2,000 cash dividend has no tax savings. Therefore, Company A's net income for 2013 and its retained earnings at the end of 2013 would be $600 higher than Company B's.

Company a and Company B Are Identical in All Regards