Question

The CFO of Daves Industries plans to have the company issue $300 million of a new common stock and use the proceeds to pay off some of its outstanding bonds that carry a 7% interest rate. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT)and its tax rate all remain constant. Which of the following would occur?A. The company’s taxable income would fall.B. The company’s interest expense would remain constant.C. The company would have less common equity than before.D. The company’s net income would increase.E. The company would have to pay less taxes.

Answer 1

D. The company’s net income would increase.

Step-by-step explanation:

The payment of outstanding bond which carry 7% interest rate will decrease the interest expense. With constant operating income the reduction in interest expense results in increase in Taxable income, tax expense and net income as well. So the correct answer is D. The company’s net income would increase.