Tax and Gearing

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W22Extra: Tax and Gearing: More Questions

Multiple Choice

1) Which of the following statements is false?
A) In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest tax shield. B) The interest tax shield is the additional amount that a firm would have paid in taxes if it did not have leverage. C) Because Corporations pay taxes on their profits after interest payments are deducted, interest expenses reduce the amount of corporate tax firms must pay. D) As Modigliani and Miller made clear in their original work, capital structure matters in perfect capital markets. Thus, if capital structure does not matter, then it must stem from a market imperfection. As Modigliani and Miller made clear in their original work, capital structure does not matter in perfect capital markets. Thus, if capital structure matters, then it must stem from a market imperfection. ------------------------------------------------------------------------------ Rosewood Industries has EBIT of $450 million, interest expense of $175 million, and a corporate tax rate of 35%. 2) Rosewood's net income is closest to:

A) $450 million
B) $180 million
C) $290 million
D) $95 million

Net income = (EBIT - Interest expense)(1 - τC)
= (450 - 175)(1 - .35) = $178.75
3) The total of Rosewood's net income and interest payments is closest to: A) $270 million
B) $355 million
C) $290 million
D) $450 million

Net income + Interest = (EBIT - Interest expense)(1 - τC)
= (450 - 175)(1 - .35) = $178.75 + $175 = $353.73

4) If Rosewood had no interest expense, its net income would be closest to: A) $405 million
B) $160 million
C) $450 million
D) $290 million

Net income = (EBIT - Interest expense)(1 - τC) = (450 - 0)(1 - .35) = $292.50

5) The amount of Rosewood's interest tax shield is closest to: A) $115 million
B) $290 million
C) $175 million
D) $60 million

Interest tax shield = Interest expense(τC) = 175(.35) = $61.25...
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