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Chapter 2: 10DQ (page 46)

Why is interest expense said to cost the firm substantially less than the actual expense, while dividends cost it 100 percent of the outlay?

Short Answer

Expert verified

Interest expense is a tax-deductible item to the company, while the dividend payments are not. So, the actual cost of interest is lower, whereas the actual cost of the dividend is exactly equal to the outlay.

Step by step solution

01

Interest expense

Interest expense is explained as the cost incurred by an organization on the borrowed amounts. It is a non-operating expense debited in the income statement as an indirect expense.

02

Dividend

A dividend is a distribution of net income earned by the company during the year to its shareholders.It is paid per-share, either in cash or by issuing a cheque or online transfer.The net cost of the interest expense to the company is the amount paid less the tax saving due to interest paid. However, in the case of dividends paid, there is no tax saving. Hence, the dividend cost is equal to the total outlay.

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