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Usagi
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Posted: 18 Dec 2011 at 04:28 \| IP Logged

Does anyone please help me to understand this?
I can't understand debt and equity finance...

Bisk 51-76

169
The benefits of debt financing over equity financing are likely to be highest in which of the following situations?

a High marginal tax rates and few noninterest tax benefits
b. Low marginal tax rates and few noninterest tax benefits
c.High marginal tax rates and many noninterest tax benefits
d. Low marginal tax rates and many noninterest tax benefits

The answer is (a)

The net cost of debt includes a factor for lower taxes due to interest expense. The tax advantages are larger when there are high tax rates as opposed to when there are low tax rate.If there are few noninterest tax benefits, it heightens the relative importance of interest benefits; they become the only vehicle for tax savings for more companies.

ramplacentia
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Posted: 19 Dec 2011 at 15:06 \| IP Logged

debt finance = you take a loan - pay interest - claim interest expense in your tax return

equity finance = you invest your own funds - pay dividends - dividends not a taxable expense - you pay more taxes

so, when marginal tax rate is high, debt financing is better.

non interest tax benefit:

If there is any scope to get a benefit by having your own funds instead of debt funds, then equity finance is better.

in a situation like - answer ( a ) debt financing is better

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Usagi
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Posted: 20 Dec 2011 at 06:32 \| IP Logged

Dear Ramplacentia,

Thank you I got the total tax difference!

But I have one more question.
What's the difference between few noninterest tax benefits and many???

Usagi

jl0329
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Posted: 20 Dec 2011 at 09:33 \| IP Logged

"It heightens the relative importance of interest
benefits; they become the only vehicle for tax savings
for more companies."

Quoted from your answer.

It's a matter of relativity. Here is my understanding,

Let's say you are starving, somebody is to offer you a
bacon cheese burger. If you have a lot of snacks in your
pocket, that burger is not that important to you because
you could just eat few snacks. On the other hand, if you
don't have these snacks, that burger is going to worth a
lot more to you.

In this case, the snacks are the noninterest benefits and
the burger is the tax saving from int. expense.

ramplacentia
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Posted: 20 Dec 2011 at 23:01 \| IP Logged

First let me explain the meaning of tax beneift

any expenditure which reduces your taxable income is considered as tax benefit.

We would first explore the possibilities for a non interest tax benefits that are available to the company, and maximize those benefits.

Usagi wrote:

Dear Ramplacentia,

Thank you I got the total tax difference!

But I have one more question.
What's the difference between few noninterest tax benefits and many???

Usagi

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