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The Corporation has $350 million in cash and 100 million shares outstanding, Suppose the corporate tax...

The Corporation has $350 million in cash and 100 million shares outstanding, Suppose the corporate tax is 20%, and investors pay no taxes on dividends, capital gains, or interest income. Investors had expected the Corporation to pay out the $350 million through a share repurchase. Suppose instead that the Corporation announces it will permanently retain the cash, and use the interest on the cash to pay a regular dividend. If there are no other benefits of retaining the cash, how will the Corporation’s stock price change upon this announcement?

A) increase by $3.5 B) decrease by $3.5 C) increase by $0.7 D) decrease by $0.7 E) Price remains the same.

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Answer #1

The Stock Price will change by = (Cash From Repurchase / No of Shares Outstanding) * Tax Rate

= 350 / 100 * 20%

= 0.70

Stock Price will fall by $0.70

option D is correct.

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