Question

Assume that you own a firm which is currently maximizing profits while operating at peak efficiency....

Assume that you own a firm which is currently maximizing profits while operating at peak efficiency. Assuming that Trump’s tax plan is enacted and the corporate tax rate were to be cut to 15%, how will this change your behavior as a manager wanting to keep those profits coming in?

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Answer #1

Tax cuts will make the manager to consider the change in optimal debt equity ratio because cost of debt will increase the interest tax shield will decrease due to lower taxes . So the manager might focus on retiring certain debt to maximize returns. Lower tax will increase net income. This can be used to expanded the business as retained earnings increase Hence growth in business increases if more amount is retained. The, manager will focus on the depreciation policy as depreciation tax shield also decreases which will affect profitability. Reduced taxes encourage more investment in core operations to increase profits.

Best of Luck. God Bless

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