COST ACCOUNTING
CAPITAL BUDGETING
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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interest expense is deductible for tax purposes.
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principal payments on debt are deductible for tax purposes.
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the cost of capital is a deductible expense for tax purposes.
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dividend payments to stockholders are deductible for tax purposes.
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Detailed explanation-1: -The cost of debt can refer to the before-tax cost of debt, which is the company’s cost of debt before taking taxes into account, or the after-tax cost of debt. The key difference in the cost of debt before and after taxes lies in the fact that interest expenses are tax-deductible.
Detailed explanation-2: -The after-tax cost of debt is more relevant because it is the actual cost of debt to the company. Interest is a tax-deductible expense which means that the entire amount of interest we pay is reduced to the extent of taxes saved from expensing the interest.
Detailed explanation-3: -Debt is also cheaper than equity from a company’s perspective is because of the different corporate tax treatment of interest and dividends. In the profit and loss account, interest is subtracted before the tax is calculated; thus, companies get tax relief on interest.
Detailed explanation-4: -This cost of debt provides interest expense which later on helps in taxation that will be a tax deduction. This interest expense is used for tax saving purposes by a company as treated as business expenses. Now, we can see that the after-tax cost of debt is one minus tax rate into the cost of debt.