Edit question Money, Inc., a U.S. corporation, has $500,000 to invest overseas.
ID: 2482947 • Letter: E
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Money, Inc., a U.S. corporation, has $500,000 to invest overseas. For U.S. tax purposes, any additional gross income earned by Money will be taxed at 34%. Two possibilities for investment are: a. Invest the $500,000 in common stock of Exco (a foreign corporation). Exco common stock pays a dividend of $3 per share each year. The $500,000 would purchase 10,000 shares (or 10%) of Exco’s only class of stock (voting common). Exco expects to earn $10 million before taxes for the year and to be taxed at a flat rate of 40%. Its current E & P before taxes is estimated to be $9.4 million. Exco’s government does not withhold on dividends paid to foreign investors. b. Invest the $500,000 in Exco bonds that pay interest at 7% per year. Assume that the bonds will be acquired at par, or face, value. Exco’s government withholds 25% on interest paid to foreign investors. Analyze these two investment opportunities, and determine which would give Money the better return after taxes
Explanation / Answer
Calculation of net income of Exco:
Exco’s total earnings= 9,400,000
Tax @ 40%= 9,400,000×0.40= $3,760,000
Net Income=$9,400,000 – $3,760,000 = $5,640,000
Calculation of net income from investing in Shares:
Number of shares to be purchased= 10,000 shares (10% of Exco’s Inc. Shares)
Dividend per share=$3 per share
Total dividend income for Money Inc= 10,000×$3 =$30,000
10% of Exco’s net profits= 5,640,000×0.10= $56,400
Exco’s share of retained earnings= $56,400– $30,000= $26,400
Tax on dividend income= $30,000×0.34= $10,200
Net Income from dividends= $30,000– $10,200= $19,800
Calculation of net income from investing in bonds:
Interest from bonds=$500,000× 0.07= $35,000
Govt. Tax in foreign $35,000× 0.25= $8,750
Net proceeds from interest from foreign country= $35,000–8,750= $26,250
Tax in US= $26,250×0.34= $8,925
Net income from Interest= $26,250– $8,925=$17,325
The Money Inc. is advised to invest in shares of Exco, since, the dividend income is more than the interest income. The retained earnings will lead to increase in the value of shares which is a capital gain to Money Inc.
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