Question

Employee stock ownership plans (ESOPs)

Why would a firm be willing to establish an employee stock ownership plan (ESOP)? Check all that apply.

a. Cash dividends paid on ESOP stock are tax deductible if the dividends are used to repay the loan that established the ESOP.

b. It is common for financial institutions to loan money to ESOPs at below-market interest rates.

c. Employers are not required to match Social Security and Medicare taxes withheld from employees’ paychecks when the employees are part of an ESOP.

Central Pull Corp. recently created an ESOP. The company issued 200,000 new shares of stock at $50 per share, which it sold to the ESOP. The ESOP borrowed $10 million to purchase the newly issued shares from the company. The financial institution was willing to lend the money to the ESOP, because Central Pull Corp. signed a guarantee for the loan. The firm used the money from the ESOP to repurchase its shares on the open market at $50 per share.

Which of the following statements describes the net effect of these transactions on Central Pull Corp.’s balance sheet?

a. The firm’s total liabilities will increase by $10 million.

b. The firm’s total shareholders’ equity will increase by $10 million.

c. The amount of the firm’s total liabilities and total shareholders’ equity will remain the same.

Answer 1

Answer : Correct options are :

a. Cash dividends paid on ESOP stock are tax deductible if the dividends are used to repay the loan that established the ESOP.

b. It is common for financial institutions to loan money to ESOPs at below-market interest rates.

Reason :

ESOP's dividend is tax deductible if used to repay the loan and financial institutions to loan money to ESOPs at below-market interest rates.

Answer : Correct option is c. The amount of the firm’s total liabilities and total shareholders’ equity will remain the same