Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur? Why?

a. The company would have to pay less taxes.

b. The company's taxable income would fall.

c. The company's interest expense would remain constant.

d. The company would have less common equity than before.

e. The company's net income would increase.

Question

Jeramiah

Business

5 June, 15:17

Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur? Why?

a. The company would have to pay less taxes.

b. The company's taxable income would fall.

c. The company's interest expense would remain constant.

d. The company would have less common equity than before.

e. The company's net income would increase.

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Answers (1)

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Richard · Answer 1

e. The company's net income would increase.

Explanation:

In this scenario the United Athletic designs is planning to issue shares of $500 million and it is assumed that the company will not pay dividends. This means there is no cost of capital. In addition total assets, operating income (EBIT), and its tax rate all remain constant. So the company is not incurring extra cost by issuing more shares.

The money gained is used to offset some debt.

This will result in increased net income of the company, as debt reduction increases income. Coupled with the fact that there is no extra cost incurred.