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 either Treasury bills yielding 3.8 percent or a 6.2 percent preferred stock. IRS regulations allow the company to exclude from taxable income 50 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 25 percent. Assume the investor has a 38 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. a-1. What is the total aftertax cash flow to shareholders if the company invests in T-bills? (Do not round Intermedlate calculations and enter your answer In dolla rs, not millons of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) 0-2. What is the total aftertax cash flow to shareholders if the company invests in preferred stock? (Do not round Intermedlate caiculations and enter your answer In dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) a-1. Value in three years 5,881,700.00 Value in three years а-2. Suppose instead that the company pays a $6 million dividend now and the shareholder reinvests the dividend for three years b-1. What is the total aftertax cash flow to shareholders if the shareholder invests in T- bills? (Do not round Intermedlate calculations and enter your answer In dollars, not millons of dollars, rounded to 2 declmal places, e.g., 1,234,567.89.) b-2. What is the total aftertax cash flow to shareholders if the shareholder invests in preferred stock? (Do not round Intermedlate calculations and enter your answer In dollars, not millions of dollars, rounded to 2 decimal places, e.g., 1,234,567.89.) b-1 Value in three years b-2 Value in three years

Answer 1

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PE EPS, STOCK DIVIDEND - Microsoft Excel (Product Activation Failed) View Add-Ins - 2x Dr General Wrap Text Merge & Center - $ :.: Insert Delete Format % , Number Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Alignment Cells File Home Insert Page Layout Formulas Data Review % Cut Calibri -11AA = = = Ea Copy Paste Format Painter BI U D- DA Clipboard Font LL935 LC LD LE LE LG 935 EXTRA CASH 6000000 936 IF INVESTMENT IS MADE IN T-BILLS 937 FUTURE VALUE OF T-BILL AFTER 3 YEARS = LH LI U LK LL LM LN LO 3.8%*(1-0.25) = AFTER TAX YIELD = 6000000*(1+0.0285)^3 = 2.85% 6527759.39 938 939 940 ANS 1 NOW DIVIDEND IS TAXABLE TO SHAREHOLDER AT 10% AFTER TAX CASHFLOW TO SHAREHOLDERS = 6527759.39*(1-0.10) = 5874983.46 941 372000 IF INVESTMENT IS MADE IN PREFERRED STOCK PREFERRED DIVIDEND = 6000000 X 6.2% = NOW 50% DIVIDEND IS TAX FREE, 50% IS TAXABLE SO 50% AMOUNT = 372000 X 50% = 186000 942 943 944 945 946 947 948 949 950 951 952 953 954 ANS 2 955 m Rea NOW TAX ON PREFERRED DIVIDEND = AFTER TAX CORPORATE DIVIDEND = SO DIVIDEND YIELD = 325500/6000000 = 51600 X 25% = 372000 - 46500 = 5.4250% 46500.00 325500.00 FUTURE VALUE OF PREFEERED STOCK INVESTMENT AFTER 3 YEARS = 7030433.09 (6000000*(1+0.05425)^3) NOW DIVIDEND IS TAXABLE TO SHAREHOLDER AT 10% AFTER TAX CASHFLOW TO SHAREHOLDERS = 7030433.09*(1-0.1) = 6327389.78 H price quote EVA MVA LEVERAGED BUY SWAP distress BRIGHAN CAP GAIN Sheeti call put bilbo arginal tax PB ROPI APV ROSS ferences: AL125 MINT SENSITIVITY EXPANIC | THE TU 120% - 0 (+) B 9 * *0 ENG 20-11-2019 6 .

PE EPS, STOCK DIVIDEND - Microsoft Excel (Product Activation Failed) File Home Insert Page Layout Formulas Data Review View Add-Ins - 2x % Cut Σ AutoSum : A Calibri -11AA = = = Dr Wrap Text General E Copy Fill Paste BI D- DA U Merge & Center - $ % , :.: Conditional Format Cell Insert Delete Format Find & Format Painter Sort & Formatting as Table Styles 2 Clear Filter Select Clipboard Font Alignment Number Styles Cells Editing LL973 LC LD L E LE LG LH L I LK LL LM LN LO 957 958 NOW IF INVESTOR RECEIVE DIVIDEND AND THE INVEST 959 960 AFTER TAX DIVIDEND RECEIVED BY SHAREHOLDERS = 6000000*(1-0.1) = 5400000 961 962 IF INVESTMENT IS MADE IN T-BILL AFTER TAX YIELD = 3.8%*(1-0.38) = 2.3560% 963 964 ANS 3 FUTURE VALUE OF T-BILL AFTER 3 YEARS = 5400000*(1+0.02356)^3 = 5790734.81 965 966 IF INVESTMENT IS MADE IN PREFERRED STOCK 967 PREFERRED DIVIDEND = 5400000 X 6.2% = 334800 968 969 NOW PERSONAL TAX RATE = 38% 970 971 NOW TAX ON PREFERRED DIVIDEND = 334800 X 38% = 127224.00 972 AFTER TAX PREFERRED DIVIDEND = 334800 - 127224 = 207576.00 973 974 SO DIVIDEND YIELD = 207576/5400000 = 3.8440% 975 976 ANS 4 FUTURE VALUE OF PREFEERED STOCK INVESTMENT AFTER 3 YEARS = 6046972.39 5400000*(1+0.03844)^3 977 m arginal tax PB ROPI APV ROSS price quote EVA MVA LEVERAGED BUY SWAP distress BRIGHAN CAP GAIN Sheeti call put bilbo MINT SENSITIVITY EXPANIC Rea ferences: AL125 B0 120% 0 + 6. B 9 . * * 10 ENG 20-11-2019 H