Question

All else being equal, if a firm issues $100 million in 10% bonds and uses the proceeds to repurchase common stock that pays dividends of $10 million per year, all of the following will occur, except:

1)income taxes will decrease

2) net income will decrease

3)interest expense will increase

4)net cash available for other needs will decrease

Answer 1

Correct option is "4" - net cash available for other needs will decrease

Interest expense on Bond is a tax deductible expense .Thus Interest expense ,net of tax will always be lower than dividend on common stock*(which is not tax deductible or are paid out of after tax profit ) which in turn increases cash available for other needs as expense is lowered or cash outflow is reduced ).

Reason for other Options :

With Increase in interest expense ,Income before income tax will decrease and which in turn decreases income tax expense and net income .