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14 November, 17:15

Interest versus dividend expense Michaels Corporation expects earnings before in - terest and taxes to be $50,000 for the current period. Assuming an ordinary tax rate of 35%, compute the firm's earnings after taxes and earnings available for common stockholders (earnings after taxes and preferred stock dividends, if any) under the following conditions: a. The firm pays $12,000 in interest. b. The firm pays $12,000 in preferred stock dividends.

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  1. 14 November, 17:24
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    a. In case of interest paid = $24,700.

    b. In Case Preferred Dividend is Paid = $20,500

    Explanation:

    Earnings before Interest And Taxes (EBIT) = $50,000

    a. In case of interest paid

    EBIT = $50,000

    Less: Interest = $12,000

    Earnings Before Taxes = $50,000 - $12,000 = $38,000

    Less: Tax @35% = $38,000 X 0.35 = $13,300

    Earnings After Tax = $38,000 - $13,300 = $24,700.

    This is the value available for common stock.

    b. In Case Preferred Dividend is Paid

    EBIT = $50,000

    Less: Taxes @ 35 % = $50,000 X 0.35 = $17,500

    Earnings After Tax = $50,000 - $17,500 = $32,500

    Less: Preference Dividend = $12,000

    Earnings available for equity or common stock = $32,500 - $12,000 = $20,500

    The difference is of tax benefit on payment of interest as that is taxable and preference dividend is not taxable.

    a. In case of interest paid = $24,700.

    b. In Case Preferred Dividend is Paid = $20,500
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