National Business Machine Co. (NBM) has $3 million of extra cash after taxes hav

Question

National Business Machine Co. (NBM) has $3 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 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 38 percent. Assume the investor has a 31 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.

Suppose the company reinvests the $3 million and pays a dividend in three years.

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, e.g. 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Suppose instead that the company pays a $3 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, e.g. 1,234,567. Do not round intermediate calculations and round your 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, e.g. 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Suppose the company reinvests the $3 million and pays a dividend in three years.

Explanation / Answer

Suppose the company reinvests the $ 3 million and pays a dividend in three years What is the total aftertax cash flow to shareholders of the company invests in preferred stock $2,655,168 Value in three years Interest on preferred stock - 4% IRS regulations allow the company to exclude from taxable income 70% of the dividends received from investing in another company's stock Corporate Tax rate - 38% Return received from preferred stock in 3 yrs- 4%*3000000*3 360000 Tax on above - 360000*30%*38% 41040 After Tax Return 318960 Cash available for reinvestment 3000000 Dividend paid to shareholders 3318960 Tax for shareholders on dividend - 3318960*20% 663792 After tax cash flow to shareholders 2655168 Suppose instead that the company pays a $ 3 million dividend now and the shareholder invests in T-Bills What is the total aftertax cash flow to shareholders if the shareholders invests in T-bills Value in three years $2,655,570 Dividend Received 3000000 Tax on dividend 450000 After tax cash available for reinvestment 2550000 Return on investment of $2550000*2%*3 153000 Tax on Interest @ 31% 47430 After tax interest 105570 After tax cash available for reinvestment 2550000 Total after tax cashflow 2655570 What is the total aftertax cash flow to shareholders if the shareholder invests in preferred stock Value in three years $2,761,140 Dividend Received 3000000 Tax on dividend 450000 After tax cash available for reinvestment 2550000 Return on Investment of $ 2550000 in preferred stock - 2550000*4%*3 306000 Tax on Dividend @ 31% 94860 After tax dividend 211140 After tax cash available for reinvestment 2550000 Total after tax cashflow 2761140

Related Questions

Navigate

• Browse (All)
• Browse N
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.