Chapter 09, Reading Question 18 In an after-tax analysis, what are the primary d

Question

Chapter 09, Reading Question 18 In an after-tax analysis, what are the primary differences between investing in a depreciable asset with the use of retained earnings (no borrowing) versus borrowed capital? The retained earnings scenario has depreciation allowances, but the borrowed capital scenario does not have depreciation allowances O The borrowed capital scenario has depreciation allowances, but the retained earnings scenario does not have depreciation allowances The retained earnings scenario has interest payments, which are deductible, but the borrowed capital scenario does not have interest payments. The borrowed capital scenario has interest payments, which are deductible, but the retained earnings scenario does not have interest payments.

Explanation / Answer

Answer,

Answer of the above question is option (d) i.e. The borrowed capital scenario has interest payments, which are deductible, but the retained earnings scenario does not have interest payments.

The basic benefit of the borrowing over the retained earnings is the availability of tax sheild due to interest payment. This benefit can provide tax advantage to company and also it helps in reducing cost of capital.

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