Debt

Question: Debt is a costly and possibly risky method of financing a company’s operations and growth. However,

advantages must exist or companies would avoid incurring noncurrent liabilities wherever possible. What are the

advantages to an organization of using debt to generate funding for operations and other vital activities?

Answer: One advantage of borrowing money is that interest expense is tax deductible. Therefore, a company will

essentially recoup a portion of its interest expense from the government. As mentioned above, Target incurred

interest expense of $900 million. This interest reduced the company’s taxable income by that amount. If the

assumption is made that Target has an effective income tax rate of 35 percent, the income tax total paid to the

government is lowered by $315 million (35 percent of $900 million). Target pays interest of $900 million but

reduces its income taxes by $315 million so that the net cost of borrowing for the period was $585 million.