7. What is the effect of the corporate income tax on the investment level of a p

Question

7. What is the effect of the corporate income tax on the investment level of a perfectly competitive corporation that finances its investment by debt (with deductible interest) and has no adjustment cost of investment? Assume that the firm is allowed to deduct economic depreciation on its capital (the change in market value of its capital during the year) in computing its taxable income. Explain and justify your answer. How might the long run effect of the corporate income tax differ in real life from the effect it has in the model of a competitive corporation? Explain.

Explanation / Answer

A corporate who finances its investment by debt will have little to invest year after year because it is the prime duity to pay the debt holder first , so when a large chunk of profit was eaten away by tax , corporate will have little to pay to debt holders and thus shareholders will go away and corporate will become less attractive to them as profit is shrinking because of high tax rate because of that Investment will also decrease.

If the company was financed by Equity, then case will be slightly different as equity holders have the last share so the company's repsonsiblity will be less as compared in the case of debt holders and thus Tax would affect less to the company.

Related Questions

Navigate

• Browse (All)
• Browse 7
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.