National Business Machine Co. (NBM) has $6 million of extra cash after taxes hav
ID: 2612640 • Letter: N
Question
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 Treasury bills yielding 3 percent or a 5 percent preferred stock. IRS regulations allow the company to exclude from taxable income 70 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 35 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 10 percent on common stock dividends. Suppose the company reinvests the $6 million and pays a dividend in three years. What is the total after tax cash flow to shareholders if the company invests in T-bills? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) What is the total aftertax cash flow to shareholders if the company invests in preferred stock? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) Suppose instead that the company pays a $6 million dividend now and the shareholder reinvests the dividend for three years. What is the total aftertax cash flow to shareholders if the shareholder invests in T-bills? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) What is the total aftertax cash flow to shareholders if the shareholder invests in preferred stock? (Enter your answer in dollars, not millions of dollars, i.e. 1,234,567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16))Explanation / Answer
OPTION 1
IF COMPANY REINVEST $6 MILLION IN TREASURY BILL AND PAY DIVIDENT IN THREE YEARS.
Investment at the end 3rd year
$6000000*1.03*1.03*1.03= $ 6556362
LESS Initial investment
$6,000,000
Income earned
556362
corporate tax rate @ 35%
194726.7
cash flow before tax in share holder hands
361635.3
Personal Divident Tax Rate @ 10%
36163.53
AFTER TAX CASH FLOW TO SHARE HOLDER
325471.77 $
OPTION 2
IF COMPANY REINVEST $6 MILLION IN PREFERRED STOCK AND PAY DIVIDENT IN THREE YEARS.
Investment at the end 3rd year
$6000000*1.05*1.05*1.05= $ 6945750
LESS Initial investment
$6,000,000
Income earned (A)
945750
Tax on 30% divident income earned
283725
(945750*30%)
corporate tax rate @ 35% (B)
99303.75
(283725*35%)
cash flow before tax in share holder hands (A-B)
846446.25
Personal Divident Tax Rate @ 10%
84644.625
AFTER TAX CASH FLOW TO SHARE HOLDER
761801.625 $
OPTION 3
IF COMPANY PAYS NOW $6 MILLION AS DIVIDENT & SHARE HOLDER INVEST IN TREASURY BILL FOR THREE YEARS.
Divident received by share holder
$6,000,000
Personal Divident Tax Rate @ 10%
600000
Balance invested in T- bill
5400000
Investment at the end 3rd year
5400000*1.03*1.03*1.03= $5900725.8
LESS Initial investment
5400000
cash flow before tax in share holder hands
500725.8
Personal Income tax Rate @ 30%
150217.74
AFTER TAX CASH FLOW TO SHARE HOLDER
350508.06 $
OPTION 4
IF COMPANY PAYS NOW $6 MILLION AS DIVIDENT & SHARE HOLDER INVEST IN PREFERRED STOCK FOR THREE YEARS.
Divident received by share holder
$6,000,000
Personal Divident Tax Rate @ 10%
600000
Balance invested in preferred stock
5400000
Investment at the end 3rd year
5400000*1.05*1.05*1.05= 6251175 $
LESS Initial investment
5400000
cash flow before tax in share holder hands
851175
Personal Income tax Rate @ 30%
255352.5
AFTER TAX CASH FLOW TO SHARE HOLDER
595822.5 $
OPTION 1
IF COMPANY REINVEST $6 MILLION IN TREASURY BILL AND PAY DIVIDENT IN THREE YEARS.
Investment at the end 3rd year
$6000000*1.03*1.03*1.03= $ 6556362
LESS Initial investment
$6,000,000
Income earned
556362
corporate tax rate @ 35%
194726.7
cash flow before tax in share holder hands
361635.3
Personal Divident Tax Rate @ 10%
36163.53
AFTER TAX CASH FLOW TO SHARE HOLDER
325471.77 $
OPTION 2
IF COMPANY REINVEST $6 MILLION IN PREFERRED STOCK AND PAY DIVIDENT IN THREE YEARS.
Investment at the end 3rd year
$6000000*1.05*1.05*1.05= $ 6945750
LESS Initial investment
$6,000,000
Income earned (A)
945750
Tax on 30% divident income earned
283725
(945750*30%)
corporate tax rate @ 35% (B)
99303.75
(283725*35%)
cash flow before tax in share holder hands (A-B)
846446.25
Personal Divident Tax Rate @ 10%
84644.625
AFTER TAX CASH FLOW TO SHARE HOLDER
761801.625 $
OPTION 3
IF COMPANY PAYS NOW $6 MILLION AS DIVIDENT & SHARE HOLDER INVEST IN TREASURY BILL FOR THREE YEARS.
Divident received by share holder
$6,000,000
Personal Divident Tax Rate @ 10%
600000
Balance invested in T- bill
5400000
Investment at the end 3rd year
5400000*1.03*1.03*1.03= $5900725.8
LESS Initial investment
5400000
cash flow before tax in share holder hands
500725.8
Personal Income tax Rate @ 30%
150217.74
AFTER TAX CASH FLOW TO SHARE HOLDER
350508.06 $
OPTION 4
IF COMPANY PAYS NOW $6 MILLION AS DIVIDENT & SHARE HOLDER INVEST IN PREFERRED STOCK FOR THREE YEARS.
Divident received by share holder
$6,000,000
Personal Divident Tax Rate @ 10%
600000
Balance invested in preferred stock
5400000
Investment at the end 3rd year
5400000*1.05*1.05*1.05= 6251175 $
LESS Initial investment
5400000
cash flow before tax in share holder hands
851175
Personal Income tax Rate @ 30%
255352.5
AFTER TAX CASH FLOW TO SHARE HOLDER
595822.5 $
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.