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Buckwold12e_ch21_Review - CHAPTER 21 TAX ASPECTS OF...

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CHAPTER 21 TAX ASPECTS OF CORPORATE FINANCING Review Questions 1. Why is it important to examine the corporate cost of financing alternatives in conjunction with the tax position of the potential investors? 2. If a corporation is subject to a 33% tax rate, why may it be advantageous for it to issue debt as opposed to preferred shares? 3. If the corporate tax rate is 16%, what difference does it make whether the corporation issues debt bearing 8% interest or preferred shares with a 6% dividend rate? 4. A corporation issues 7% bonds as well as preferred shares with an annual 4% dividend rate. Excluding the risk factor, what type of investor would prefer the bond and what type would prefer the shares? Explain. 5. An investor who is an individual could earn a 10% return either from shares that pay a low dividend and have high growth or from shares that pay a high dividend and have low growth. Assuming that the risk related to each is the same, which investment would the individual prefer? 6. If the cost of preferred share financing is so much greater than debt, why are such securities issued by public corporations? 7. Briefly describe the tax treatment applied to expenses incurred to issue shares or borrow money (the cost of a prospectus, commissions to brokerage firms, and the like). What impact does this tax treatment have on the after-tax cost of financing? 8. If a corporation issues a bond at a price less than the face value of the security, the discount is amortized, for accounting purposes, over the life of the bond. How does this treatment of the discount compare with the treatment for tax purposes? 9. If a corporation issues a bond at a discount, will the after-tax cost of financing to the issuing corporation be higher or lower than if it had issued the bond at its face value? Explain. 10. Is the after-tax return to a casual investor who purchases a bond at a discount greater than or less than the after-tax return on a bond purchased at its face value? Explain.
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11. How does the issuing of a bond at a premium affect the after-tax cost of financing to the corporate issuer? 12. Explain the difference between a financial lease and an operating lease. 13. What is the difference, in tax terms, between leasing and owning?
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Solutions to Review Questions R21-1. The buyers of corporate securities include individuals, private corporations, other public corporations, and an array of pension and other investment funds. The tax treatment of investment returns for each type of investor may vary. Therefore, certain investors prefer certain types of securities because of the particular tax treatment, and may be prepared to pay a higher price than other investors for the same investment. In order to take advantage of a tax sensitive market, the corporation issuing securities must be familiar with investor tax concerns in order that a cost efficient financing structure is developed.
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