Question

why is debt financing said to include a tax shield for the company? 1. taxes are reduced by the amount of the interest 2. taxable income is reduced by the amount of the interest. 3. taxable income is reduced by the amount of the debt 4. taxes are reduced by the amount of the debt.

Answer 1

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3. taxable income is reduced by the amount of the debt ✔

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Answer 2

Answer:

Option 1 - Taxes are reduced by the amount of the debt is the correct option.

Explanation:

• The amount of interest is deducted from taxes. The amount of the debt is deducted from taxable income.

• The tax benefits of debt, also known as the tax advantage of debt, refers to the fact that it is less expensive for businesses and investors to fund with debt than equity.

• Firms are taxed on their profits in the majority of taxation systems around the world, and individuals are taxed on their income until recently in the United States tax system.
• As a result, these payments will be exempt from corporate income tax, leaving lenders with only personal income tax to pay (interest payments are only taxed once).
• Corporations can avoid double taxation by choosing loan financing over stock financing.

Hence, the tax shield is the name for this concept, it is the tax reduced by the amount of the interest.

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