Question

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 select one:

a. corporation a's gross profit will decrease.
b. corporation a's operating income will decrease due to higher interest expense.
c. corporation a's net income will increase due to the tax deductibility of interest expense.
d. corporation a will have no change in its operating income since the interest expense exactly offsets the prior dividend payment.

Answer 1

corporation a's net income will increase due to the tax deductibility of interest expense.

Answer 2

Answer: C. Corporation a's net income will increase will increase to the tax deductibility of interest expense

Step-by-step explanation

Corporation a borrowed $ 1000 000 to buy back common stock. The interest payments of 60 000 (1000 000 x 0.06) will be claimed as a tax deduction that is interest expense is a tax deductible expense. When interest payments are deducted the taxable income amount will decrease by $60 000 which will result in the company paying lower income tax. Paying lower income tax will increase the net income or earnings after tax