23. If there are two companies, with identical Gross profit figures, but company A is all equity financed and company B has a loan. Tax is payable on Earnings after Interest. The impact on profit and Tax would be:

A. Company A would have higher profits than company B, and therefore a higher tax bill than company B.

B. Company A and Company B would have the same pre-tax profit, but company A would pay more tax

C. Company A would have lower profits than company B, and therefore a lower tax bill than company B

D. There is no difference in the profit or tax of A and B

Answer : D

Using some simple numbers to illustrate, suppose the Gross Profit of each is £10,000 and expenses are £5,000. B also has interest of £1,000 to pay.
So A has a pre-tax profit of £5,000 which is higher than B, £4,000
If tax is 20% then A pays £1,000 and B pays less, £800.
The post-tax profits are £4,000 and £3,200 respectively. B has paid less in tax. But it also has less money available to shareholders.
So, some debt is good – because it reduces the tax bill. Note that this only works if the company IS making a profit!