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# Interest versus dividend income

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Interest versus dividend income

During the year just ended, Shering Distributors, Inc., had pretax earnings from operations of \$490,000. In addition, during the year it received \$20,000 in income from interest on bonds it held in Zig Manufacturing and received \$20,000 in income from dividends on its 5% common stock holding in Tank Industries, Inc. Shering is in the 40% tax bracket and is eligible for a 70% dividend exclusion on its Tank Industries stock.

a. Calculate the firms tax on its operating earnings only.

b. Find the tax and the after-tax amount attributable to the interest income from Zig Manufacturing bonds.

c. Find the tax and the after-tax amount attributable to the dividend income from the Tank Industries, Inc., common stock.

#### Solution Preview

a. Calculate the firms tax on its operating earnings only.

After-tax earnings = Pre-tax earnings * (1-tax rate)
After-tax earnings = \$490,000 * (1-.40)
After-tax earnings = \$294,000

b. Find the tax and the after- tax amount attributable to the interest income from Zig Manufacturing bonds.

Tax on bond interest = Bond interest ...

#### Solution Summary

This solution illustrates how to compute a corporation's tax on its operating earnings, interest income, and dividend income.

\$2.19
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## Debt versus Equity Financing (Interest versus Dividends)

Aside from taxes, another important difference between debt and equity financing is that debt payments must be made to avoid default, while firms have no similar obligation to pay dividends. How do debt and equity financing affect a firm's tax situation differently? Why do debt payments have to be made but dividends do not have to be paid?

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