After completing its capital spending for the year, Carlson Manufacturing has $2
ID: 2709133 • Letter: A
Question
After completing its capital spending for the year, Carlson Manufacturing has $2,500 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 3 percent or paying out the cash to investors who would invest in the bonds themselves.
a. If the corporate tax rate is 33 percent, what personal tax rate would make the investors equally willing to receive the dividend or to let Carlson invest the money? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)
b. Is the answer to (a) reasonable? Yes No
c. Suppose the only investment choice is a preferred stock that yields 11 percent. The corporate dividend exclusion of 70 percent applies. What personal tax rate will make the stockholders indifferent to the outcome of Carlson’s dividend decision? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)
d. Is this a compelling argument for a low dividend-payout ratio? Yes No
Explanation / Answer
[a] It is given that corporata Tax is 33% and it will be presumed that Carlson Manufacturing is a corporate Assessee and corporare rate of Tax is applicable.
Therfore paying out dividend to the shareholder / stakeholder : -
Post Tax Worth in their hand:
$2500 x [3% x 0.67] = 2500X2.01%
=$50.25. yearly income from the dividend pay out of full surplus - assumed it is out odf profir or retained earnings]
alternatively:
treasuty bond investment will yield post tax surplus $50.25
if the shareholder is corporate assessee .
The pay our of $ 2500 will be taxed 33% that means $1675.00.
to yield income $50.25 , yield 1675 / 3000 = 55.83%.
[b]
yes it is reasonable.
[c]
The 70 % excusion implies that only 30% pay out is feasible.
therefore 11X.30 = dividend is expected to 3.30 % [ percent ]on invested value.
About 10% of personal tax rate will be indifferent to carlson mfg dividend decision.
i.e. 3/ 3.30 = 90.90 post tax yield , therefore the investor can paypersonal tax upto 9.10%.
[D] Yes, it is an argument for low dividend pay out ratio. if the pay out ratio is better than #0% , the investment will be more attractive.
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