Rhett Co., which produces and sells biking equipment, is financed as follows: Income tax is...

Question:

Rhett Co., which produces and sells biking equipment, is financed as follows: Income tax is estimated at 40% of income. What factors other than earnings per share should be considered in evaluating alternative financing plans?

a. Bonds represent a fixed annual interest requirement, while dividends on stock do not.

b. Dividends reduce retained earnings.

c. Bond holders exercise control over board of directors decisions.

d. Stock must be paid annual dividends.

e. Net income is reduced by dividend expense.

Financing Decisions:

Financing decisions are decisions that must be made by an organization. Financing decision includes decisions based on the level of finances required, the sources of finances to obtain capita from and the cost of obtaining those finances. These decisions are essential as they will affect liquidity ratios and profit levels of a company.

Answer and Explanation:

The correct answers are;

a. Bonds represent a fixed annual interest requirement, while dividends on stock do not.

This is essential to consider since the interest on bonds must be paid but its not a must for shareholders to receive dividends. Therefore, the use of bonds to finance company operations will be more expensive than using stock.

b. Dividends reduce retained earnings.

Dividends are usually paid from retained earnings. Retained earnings is one of the sources of internal sources of finance. Therefore, when dividends are paid they will reduce retained earnings, therefore, it is essential to set an effective dividend payout ratio.


Learn more about this topic:

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What Is Financing? - Definition & Types

from Corporate Finance: Help & Review

Chapter 8 / Lesson 7
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