Question

You manage a? (tax-free) pension fund that is invested in KOA Corporation.? KOA's managers have just announced that they unexpectedly generated an extra ?$50 million in cash flow this year. They are considering paying it out now as a special dividend or investing it in? one-year Treasury securities that will earn 1.0?% interest over the next year. They would then distribute the $50 million plus interest earned as a special dividend. If KOA pays a 35% corporate tax? rate, would you prefer they pay the $50 million as a special dividend now or wait a? year?

Answer 1

I would prefer to pay Special Dividend now.

The reason is simple, if i Invest in one year treasury securities, then both $50 million + Interest will be charged for tax. and if i pay dividend in pension free funds now, then we will get exemption in corporate tax $50 million.

If i pay dividend now.... tax liabilities will be zero

if i invest in one treasury securities then pay special dividend... the tax will be on 50 million + 1% interest = $50.5 million. Tax will be 35% of $50.5 million = 17.675, and amount remains for investing in pension fund will be 32.865.

so its better to give special dividend now