Question

As an investor, you are faced with a marginal federal tax rate of 29% and a provincial tax rate of 11.16%. You have $30,000 available to invest for 1 year at which time you will cash in your investment and purchase a new car. Your investment opportunities include: (a) investing in a one year term deposit offering a guaranteed return of 4% or (b) investing in the preferred shares of Z Ltd. with a stated dividend of $.20 per share. The shares are currently selling at $16, and are expected to be selling for $16.30 in one year. You anticipate receipt of the dividend prior to selling the shares. REQUIRED: Which investment would you prefer? Why? (SHOW ALL CALCULATIONS)

Answer 1

Inorder to be able to decide which investment is better we should compare the rate of return under both the plans.

1. Term deposit would give a 4% return on investment, after tax the return would be 4 (1-29%) = 2.84%

2. Investment in shares would give 0.5 per share return that is for every $16 invested the return would be $0.5 (including dividend income). So the return would be 0.5/16 = 3.125%. After tax return would be 3.125 (1-11.16%) = 2.78%

Of the above options the term deposit would be the better option because even after considering only expected return from investment in shares the term deposit would give more return. Further investment in shares is also subject to market risks.