2-10DQ Why is interest expense said to ... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 2: 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

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.

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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	20X1	20X2
Sales	\(3,230,000	\)3,370,000
Cost of goods sold	2,130,000	2,850,000
Gross profits	\(1,100,000	\)520,000
Selling and administrative expenses	298,000	227,000
Operating profits	\(802,000	\)293,000
Interest expense	47,200	51,600
Income before taxes	\(754,800	\)241,400
Taxes (35%)	264,180	84,490
Income after tax	\(490,620	\)156,910

Sales	1,360,000
Shares outstanding	104,000
Cost of goods sold	700,000
Interest expenses	34,000
Selling and administration expenses	49,000
Depreciation expenses	23,000
Preferred stock dividend	86,000
Taxes	100,000

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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

Step by step solution

Interest expense

Dividend

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