Question

Companies HD and LD have the same sales, tax rate, interest rate and their debt, total assets, and basic earning power. Both companies have positive net income. Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is correct?
a) Company HD pays less in taxes.
b) Company HD has lower equity multiplier.
c) Company has a higher ROA.
d) Company HD has a higher times-interest-earned (TIE) ratio.
e) Company HD has mor

Answer 1

Answer:

A) company HD pays less in Tax

Explanation:

Because interest is deducted before tax in income statement. Higher interest means less Earning before tax, and less amount of Tax be deducted.

HD and LD both have same Earning before interest and tax.

Let suppose both have  EBIT of $1000,

Not HD has interest expense of 150, and LD has interest expense of $100

Now HD Earning before tax would be 850, and LD EBT would be 900.

Let's say tax is 40%

so,

HD tax would be 850*0.4=340

LD tax would be 900*0.4=360

So, HD pays higher interest, it benefit company in paying lower tax amount. bacause interest is tax saving.

HD saves $20 in this hypothetical example.