Which of the following statements is true? Multiple Choice 1. Dividends to stockholders are tax deductible. 2. Interest on bonds is not tax deductible. 3. Bonds do not have to be repaid. 4. Interest on bonds is tax deductible. 5. Bonds always increase return on equity
Business · High School · Thu Feb 04 2021
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The statement that is true among the given options is 4. "Interest on bonds is tax deductible." Companies can deduct interest payments made on bonds from their corporate income, which effectively reduces their taxable income.
Let's delve a bit into each of the statements to clarify why the others are not correct:
1. Dividends to stockholders are tax deductible. - This statement is false. Dividends paid to shareholders are not tax deductible for the corporation. Dividends are paid out of after-tax profits, meaning the corporation pays taxes on its income first, and then it distributes part of the remaining profits as dividends.
2. Interest on bonds is not tax deductible. - This is incorrect. As mentioned above, the interest that a company pays to bondholders is indeed tax deductible. This is one of the key advantages for a company to issue bonds as compared to issuing more stock, which could involve paying non-deductible dividends.
3. Bonds do not have to be repaid. - This statement is false. Bonds are a form of debt financing, which implies that the issuer is obligated to pay back the principal amount of the bonds (known as the face value) on a specified maturity date. During the life of the bond, the issuer also pays interest to bondholders.
5. Bonds always increase return on equity. - This statement is not always true. While it is possible for the use of debt (such as bonds) to increase return on equity (ROE) through financial leverage, this outcome is not guaranteed. When a company uses debt financing, it can increase the return to shareholders if the company earns a higher rate of return on its investments than the interest rate it pays on the debt. However, if the cost of debt exceeds the returns generated by the company, it can lead to a decrease in ROE. This relationship is described by the concept of leverage.