Question

Explain, from the perspective of corporate financing, the different tax implications between interest payment to lenders and dividend payment?

Answer 1

Interest payment to lenders are part of debt of the firm. The interest expenses are tax deductible and form a tax shield which helps the firm save money. Interest expenses are paid to lenders. Debt is a form of financing for running / expanding the company.

Dividend is a portion of the net profits of the company which is paid to shareholders. It is discretionary for the management. Dividend payout ratio determines the amount of dividends paid. The rest of the net profit is retained as retained earnings for running / expanding the business. So, more the dividend, less the amount left for retaining for growth / normal operations of the firm.