Question

Assume the corporate tax rate is 15 percent, the personal tax rate on interest income is 15 percent, and the personal tax rate on dividends is 20 percent. If the firm earns $5 per share in taxable income and pays out 55 percent of its earnings, how much will a shareholder receive in aftertax income? Question 18 options: $1.87 $1.78 $1.97 $1.67 $1.19

Answer 1

Taxable income of firm per share = $5, Corporate tax rate = 15%

Net income available to shareholders per share = Taxable income of firm per share x (1 - Corporate tax rate) = 5 x ( 1 - 15%) = 5 x 85% = $4.25 per share

Since the firm pays 55% of its earnings, therefore dividend payout ratio = 55%

Dividend paid per share = net income available to shareholders per share x dividend payout ratio = 4.25 x 55% = $2.3375

Personal tax rate on dividends = 20%

After tax income received by shareholder = dividends per share x ( 1 - personal tax rate on dividends) = 2.3375 x (1 - 20%) = 2.3375 x 80% = 1.87

Hence after tax income received by shareholder = $1.87