During the last few years, many companies have suffered major trading losses bec

Question

During the last few years, many companies have suffered major trading losses because of the poor economic climate. Assume your firm has found itself in this situation and is considering a major redevelopment investment to exploit growth opportunities. Due to large losses incurred in recent years, your firm has significant tax loss carry-forwards, which means that it does not need to pay any tax for 3 years. Should you use debt or equity to finance the firm's redevelopment investment? Explain your choice.

Explanation / Answer

Company can get tax benefit on the interest payment. Here in this case company has remaining tax carry forward that is company need not to pay tax for next 3 year. If company wants to take benefit of tax carry forward then it should use equity for the redevelopment. This is because in normal case company has to pay tax on the profit if it employed equity for redevelopment, but because of tax carry forward by employing equity company need not to pay tax.

If company use debt then in normal case or tax carry forward company get tax benefit on interest payment.

Hence, to utilize the tax carry forward company should use equity for redevelopment.

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