National Business Machine Co. (NBM) has $4.1 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 1.9 percent or a 4.3 percent preferred stock. IRS regulations allow the company to exclude from taxable income 50 percent of the dividends received from investing in another company's 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 21 percent. Assume the investor has a 28 percent personal income tax rate, which is applied to interest income and preferred stock dividends. The personal dividend tax rate is 10 percent on common stock dividends.
National Business Machine Co. (NBM) has $4.1 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 1.9 percent or a 4.3 percent preferred stock. IRS regulations allow the company to exclude from taxable income 50 percent of the dividends received from investing in another company's 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 21 percent. Assume the investor has a 28 percent personal income tax rate, which is applied to interest income and preferred stock dividends. The personal dividend tax rate is 10 percent on common stock dividends.
Chapter15: Dividend Policy
Section: Chapter Questions
Problem 7P
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Vijay
Transcribed Image Text:National Business Machine Co. (NBM) has $4.1 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 1.9 percent or a 4.3 percent preferred stock. IRS regulations allow the company
to exclude from taxable income 50 percent of the dividends received from investing in
another company's 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 21 percent. Assume the investor has
a 28 percent personal income tax rate, which is applied to interest income and preferred
stock dividends. The personal dividend tax rate is 10 percent on common stock
dividends.
Suppose the company reinvests the $4.1 million and pays a dividend in three years.
a-1. What is the total aftertax cash flow to shareholders if the company invests in T-bills?
(Do not round intermediate calculations and enter your answer in dollars, not
millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)
a-2. What is the total aftertax cash flow to shareholders if the company invests in
preferred stock? (Do not round intermediate calculations and enter your answer in
dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.)
a-1. Value in three years
a-2. Value in three years
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