Firm A currently shows assets worth 2,000 and equity of 1,500. During the year, it capitalized interest expense worth 200, of which 50 was depreciated/amortized.
The firm faces a tax rate of 50%. If the firm had expensed the interest paid, which of the following would be true?
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A. B. C. D.B
If the firm's assets without capitalization equal A, then we have A+200-50 = 2,000. Hence, A = 1,850.
To determine the impact of expensing the interest paid on the firm's assets, we need to understand how capitalizing interest expense affects the financial statements.
When interest expenses are capitalized, they are added to the cost of acquiring or constructing an asset. This increases the value of the asset and is reflected in the balance sheet. In this case, the interest expense capitalized is $200.
However, it's mentioned that $50 of the capitalized interest was depreciated/amortized. Depreciation or amortization represents the systematic allocation of the cost of an asset over its useful life. It reduces the value of the asset on the balance sheet.
Now, let's consider the scenario where the firm expensed the interest paid instead of capitalizing it. By expensing the interest, it would be deducted from the firm's earnings in the income statement, reducing net income.
The tax rate of 50% is applied to the net income to calculate the tax liability. This tax liability would also reduce equity in the balance sheet.
Since the interest expense is expensed, it would not impact the assets directly. Therefore, the assets would remain the same at $2,000.
Hence, the correct answer is:
C. Its assets would be stated at 2,000.