Question

Mantle Corporation is considering two equally risky investments It can take advantage of the IRS’s 70% dividend exclusion from income tax on dividends.

?         A $5,000 investment in preferred stock that yields 6.95%.

?         A $5,000 investment in a corporate bond that yields 10.00%.

TASK: Please calculate the breakeven corporate tax rate that makes the company indifferent between the two investments.

Answer 1

		OPTION A:PREFERRED STOCK
	A	Investment	$5,000
	B	Dividend Yield	6.95%
	C=A*B	Dividend amount	$347.50
	D=C*0.7	Exclusion from income tax	$243.25
	E=C-D	Taxable Income	$104.25
		Tax Rate =T
		Tax amount=104.25*T
		After tax receipt=Ra=347.50-104.25T
		OPTION B:PREFERRED STOCK
	A	Investment	$5,000
	B	Interest yield	10.00%
	C=A*B	Interest amount	$500.00
		Tax Rate =T
		Tax amount=500*T
		After tax receipt=Rb=500*(1-T)
		At breakeven corporate tax rate:
		Ra=Rb
		347.50-104.25T=500*(1-T)
		347.50-104.25T=500-500T
		(500-104.25)*T=500-347.50
		395.75*T=152.5		395.75	152.5
		T=152.5/395.75=	0.385344
		Breakeven Corporate tax rate=T=	0.385344
		Breakeven Corporate tax rate (Percentage)	38.5%