Corporation A decides to borrow $1,000,000 and use the money to buy ba

Corporation A decides to borrow $1,000,000 and use the money to buy back $1,000,000 of its
common stock.

The corporation pays 6% interest on its borrowed funds which exactly equals the
amount of the dividend it used to pay on the common stock it repurchased. Therefore,
A) Corporation A’s net income will increase due to the tax deductibility of interest expense.
B) Corporation A’s gross profit will decrease.
C) Corporation A will have no change in its operating income since the interest expense exactly
offsets the prior dividend payment.
D) Corporation A’s operating income will decrease due to higher interest expense.

ANSWER

A