Question

Suppose that all capital gains are taxed at a 23% ​rate, and that the dividend tax rate is 41%. Arbuckle Corp. is currently trading for ​$43​, and is about to pay a ​$5 special dividend.

a. Absent any other trading frictions or​ news, what will its share price be just after the dividend is​ paid?

Suppose Arbuckle made a surprise announcement that it would do a share repurchase rather than pay a special dividend.

b. What net tax savings per share for an investor would result from this​ decision?

c. What would happen to​ Arbuckle's stock price upon the announcement of this​ change?

Answer 1

Solution-

Part a-  Absent any other trading frictions or​ news, what will its share price be just after the dividend is​ paid?

Effective Dividend Rate- (0.41- 0.23) / (1- 0.23) = 23.33%

Share price after dividend is paid- $43 - $5 * (1- 0.23)= $43 - $3.85 = $39.15

Part b- What net tax savings per share for an investor would result from this​ decision?

Dividend Tax- $5 * 0.41 = $2.05

Tax Saving - $3.85 * 0.23= $0.89

Net Tax Saving- $2.05- $0.89= $1.61

Part c- What would happen to​ Arbuckle's stock price upon the announcement of this​ change?

New Stock Price- $43 + $1.61= $44.61 (Gain/Increase)