Answer:
e) while earnings available to pay interest rise, earnings to residual owners rise faster.
Explanation:
The interest expense is a fixed expense, it is not the distribution of profits and with that, there arises a tax benefit for the equity or common stockholders.
As there is no tax benefit on distribution of profits the proportionate earnings, accordingly increases.
As the interest is paid from earnings and assuming 30% tax rate and interest to be $100,000 then the effective interest payment is $70,000, because 30% tax benefit is there, that is with this 100,000 [tex]\times[/tex] 30% = $30,000 is decreased from earnings to be given to government and is now available for equity.
