GK
ACCOUNTING
|
Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
|
|
|
Rate of Interest
|
|
|
Time value of Money
|
|
|
Tax deductibility of Interest
|
|
|
Dividends not payable to lenders
|
Detailed explanation-1: -The firm gets an income tax benefit on the interest component that is paid to lender. Therefore, the net taxable income of the company is reduced to the extent of the interest paid. All other sources do not provide any such benefit and hence, it is considered as a cheaper source of finance.
Detailed explanation-2: -Debt is cheaper than equity for several reasons. However, the primary reason for this is that debt comes without tax. This means that when we choose debt financing, it lowers our income tax. It helps remove the interest accruable.
Detailed explanation-3: -Indeed, debt has a real cost to it, the interest payable. But equity has a hidden cost, the financial return shareholders expect to make. This hidden cost of equity is higher than that of debt since equity is a riskier investment. Interest cost can be deducted from income, lowering its post-tax cost further.