Form an opinion on the destructibility of Interest Expense, called the Tax Shield of Debt. Analyze #18, 19, 20. Do you think – Keep it, eliminate it, or Modify it, and explain why. State you your position and brief defense of it. Length, must be around150 words. To develop an opinion, you MAY read. The three articles below. Or, use your collective knowledge to briefly defend your opinion.
Why is the after-tax cost of debt the relevant cost for a firm instead of the before-tax cost? This is due solely to U.S. public policy that allows interest expense to be deducted from income, which lowers a firm’s taxable income and, therefore, lowers the firm’s tax liability. This is sometimes called THE TAX SHIELD OF DEBT
19. Are there any observed effects from this policy?
Answer is: Yes. One observation is that firms with some debt tend to have a higher
stock price than comparable firms without any debt.
20. Could the relevant cost for debt ever change?
Answer is: YES. If public policy changed and this is debated on a regular basis, as are similar public policies, such as dividends not being treated as an “expense;” depreciation and amortization being treated as cash expenses when they are not, even if they represent future cash replacement costs, etc
Article 1. A history of the policy that permits corporate interest expense to be deductible is at link below.
http://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=5612&context=faculty_scholarship
Article 2. An example of support for the policy is at the link below.
http://www.bloomberg.com/news/articles/2013-05-29/corporate-interest-deduction-proves-sacred-amid-reformers-taxes
Article 3. An example of opposition to the policy is at the link below.
http://www.fool.com/investing/general/2012/09/24/stop-bribing-companies-to-lever-up.aspx
