Firm ABC' stock price is currently $100 and there are 1 million shares outstanding. All investors in firm ABC purchased their stock 5 years ago when the price was $50. ABC is sitting on top of $10 million in extra cash that it does not need to fund its operations. With the exception of possible income from this cash, the earnings of ABC are expected to be constant for the foreseeable future. The corporate tax rate is 35%, the personal tax rate on interest income is 30%, and the personal tax rate on dividends and capital gains is 15%. ABC is considering the following options:
(a) Pay the $10 million out in a special dividend today to investors who will invest the cash in T-bills offering an 8% return for the next 5 years.
(b) Pay the $10 million out in the form of a share repurchase today to investors who will invest the cash in T-bills offering an 8% return for the next 5 years
(c) Hold onto the cash and invest it in T-bills offering an 8% return. Pay the cash and interest out to investors in the form of a special dividend after 5 years.vv
Firm ABC' stock price is currently $100 and there are 1 million shares outstanding. All investors in firm ABC purchased their stock 5 years ago when the price was $50. ABC is sitting on top of $10 million in extra cash that it does not need to fund its operations. With the exception of possible income from this cash, the earnings of ABC are expected to be constant for the foreseeable future. The corporate tax rate is 35%, the personal tax rate on interest income is 30%, and the personal tax rate on dividends and capital gains is 15%. ABC is considering the following options:
(a) Pay the $10 million out in a special dividend today to investors who will invest the cash in T-bills offering an 8% return for the next 5 years.
(b) Pay the $10 million out in the form of a share repurchase today to investors who will invest the cash in T-bills offering an 8% return for the next 5 years
(c) Hold onto the cash and invest it in T-bills offering an 8% return. Pay the cash and interest out to investors in the form of a special dividend after 5 years.vv
Related questions
| National Business Machine Co. (NBM) has $6 million of extra cash after taxes have been paid. NBM has two choices to make use of this cash. One alternative is to invest the cash in financial assets. The resulting investment income will be paid out as a special dividend at the end of three years. In this case, the firm can invest in either Treasury bills yielding 2 percent or a 4 percent preferred stock. IRS regulations allow the company to exclude from taxable income 70 percent of the dividends received from investing in another companyâs stock. Another alternative is to pay out the cash now as dividends. This would allow the shareholders to invest on their own in Treasury bills with the same yield, or in preferred stock. The corporate tax rate is 36 percent. Assume the investor has a 30 percent personal income tax rate, which is applied to interest income and preferred stock dividends. The personal dividend tax rate is 20 percent on common stock dividends.
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