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ACC501 Business Finance , GDB # 1 , Opening date November 18, 2014 , Closing date November 25, 2014 (marks 5)

Important announcement

Graded Discussion Board

Business Finance (ACC501)

 

Dear Students!

This is to inform that Graded Discussion Board (GDB) No. 01 will be opened on November 18, 2014 for discussion and last date for posting your discussion will be November 21, 2014.

 

Topic/Area for Discussion

 “Tax Shield”

 

This Graded Discussion Board will cover first 06 lessons.

 

Discussion Question:

If a company induces debt in its capital structure, it gets tax advantage i.e. its tax liability is reduced. This particular tax advantage is known as tax shield. Theoretically, it can be said in this case that the overall capital of a company should be financed through debt in order to avail maximum advantage. Is it practically possible and feasible? Discuss its impact on business entity.

Important Instructions:

  1. Your discussion must be based on logical facts.
  2. Do not copy or exchange your answer with other students. Two identical / copied comments will be marked Zero (0) and may damage your grade in the course.
  3. Obnoxious or ignoble answer should be strictly avoided.
  4. Questions / queries related to the content of the GDB, which may be posted by the students on MDB or via e-mail, will not be replied till the due date of GDB is over.

Views: 4046

Replies to This Discussion

exactly princess mesum, i also wanna ask this.........plz anyone help about,waiting for response

Debt is always not feasible for capital structure as if all the capital we finance with debt we will get the benefits of Tax shield but in other way we have risk also for return back the debt amount, If our business shutdown and we will be unable to pay the debt we have to pay from our pockets or from our properties, like bankruptcy.......Hope its understandable... 

I agree with Pirates. Agar total capital he debt ho to company bound ho jae ge.  Q k debt k lia company ko Bank ke sare sharait banni perti han. or cast pir bhe Bank k pas he rahta h or businessman k btany k bad bank khod sy company ko machinery etc, etc. buy kar k dyta h. Ab jaldi sy apny comment dain. M i right or wrong??

yes it is practically possible ..
for example:
interest on debt is an tax deductible expense , taking on debt can act as a tax shield . tax efficient investing strategies are cornerstone of investing for high net worth individuals and corporations, whose annual tax bills can be very high the ability to use home mortgage as a tax shield is a major benefit for many middle class people whose home are a major component of their net worth.

Corporate Finance - Effects of Debt on the Capital Structure

Using Greater Amounts of Debt
Recall that the main benefit of increased debt is the increased benefit from the interest expense as it reduces taxable income. Wouldn't it thus make sense to maximize your debt load? The answer is no.

With an increased debt load the following occurs: 
Interest expense rises and cash flow needs to cover the interest expense also rise.
Debt issuers become nervous that the company will not be able to cover its financial responsibilities with respect to the debt they are issuing.

Stockholders become also nervous. First, if interest increases, EPS decreases, and a lower stock price is valued. Additionally, if a company, in the worst case, goes bankrupt, the stockholders are the last to be paid retribution, if at all. 

A company needs financial capital in order to operate its business. For most companies, financial capital is raised by issuing debt securities and/or by selling common stock. The amount of debt and equity that makes up a company’s capital structure has many risk and return implications. Therefore, corporate management has an obligation to use a thorough and prudent process for establishing a company’s target capital structure. The capital structure is how a firm finances its operations and growth by using different sources of funds.

Financial leverage is defined as the extent to which fixed-income securities and preferred stock are used in a company’s capital structure. Financial leverage has value due to the interest tax shield that is afforded by the U.S. corporate income tax law. The use of financial leverage also has value when the assets that are purchased with the debt capital earn more than the cost of the debt that was used to finance them. Under both of these circumstances, the use of financial leverage increases the company’s profits. With that said, if the company does not have sufficient taxable income to shield, or if its operating profits are below a critical value, financial leverage will reduce equity value and thus reduce the value of the company. 

tax shield is the reduction in income taxes that results from taking an allowable deduction from taxable income.[1]For example, because interest on debt is a tax-deductible expense, taking on debt creates a tax shield.[1] Since a tax shield is a way to save cash flows, it increases the value of the business, and it is an important aspect of business valuation.

ebt is always not feasible for capital structure as if all the capital we finance with debt we will get the benefits of Tax shield but in other way we have risk also for return back the debt amount, If our business shutdown and we will be unable to pay the debt we have to pay from our pockets or from our properties, like bankruptcy

I think Debt is always not feasible for capital structure as if
all the capital we finance with debt we will get the benefits
of Tax shield but in other way we have risk also for return
back the debt amount. Interest expense rises and cash flow
needs to cover the interest expense also rise. Interest
expense rises and cash flow needs to cover the interest
expense also rise. Debt issuers become conscious that the
company will not be able to cover its financial
responsibilities with respect to the debt they are issue.
Stockholders become also worried. If interest increases
EPS decreases and a lower stock price is valued.

A tax shield is the reduction in income taxes that results from taking an allowable deduction from taxable income. For example, because interest on debt is a tax-deductible expense, taking on debt creates a tax shield.

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