Help with financing ?

Question

1. With a Subchapter S corporation  
  a)  corporate income is taxed as direct income to stockholders.  
  b) stockholders have the same liability as members of a partnership.  
  c) the number of stockholders is unlimited.  
  d) life of the corporation is limited.  

2.  A higher interest rate (discount rate) would  
   a) reduce the price of corporate bonds.  
   b)reduce the price of preferred stock.  
   c)reduce the price of common stock.  
   d)all of the above.  

3. Corporations prefer bonds to preferred stock for financing their operations because  
    a)preferred stocks require a dividend.  
    b)bond interest rates change with the economy while stock dividends remain constant.  
   c)the after-tax cost of debt is less than the cost of preferred stock.  
   d)none of the above

jerry-the-bookkeeper · Accepted Answer

1 a - The whole purpose of an S corporation is to eliminate federal corporate income tax.  This is done by passing the profits on as taxable income of the shareholders.

2 a - Suppose a bond has a par value of $100 and a 5% interest rate.  Now suppose interest rates climb to 10%.  In order to yield a competitive return the price of the bonds would have to fall (in this case to $50).

3 d - I arrived at this by a process of elimination.
  a doesn't make sense since bonds require interest payments and preferred stocks require dividends.
  b doesn't make sense since the corporation pays the same interest dollars on the bonds regardless of what they are selling for.
  c - isn't true.  dividends come out of taxable profits.  Bond interest is an expense which reduces profits, but also reduces the tax liability

Hope this helps
Jerry-the-bookkeeper

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Help with financing ?

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