Question

Suppose that all capital gains are taxed at a 30 % ​rate, and that the dividend...

Suppose that all capital gains are taxed at a 30 % ​rate, and that the dividend tax rate is 42 % . Arbuckle Corp. is currently trading for ​$39 ​, and is about to pay a ​$6 special dividend. a. Absent any other trading frictions or​ news, what will its share price be just after the dividend is​ paid? Suppose Arbuckle made a surprise announcement that it would do a share repurchase rather than pay a special dividend. b. What net tax savings per share for an investor would result from this​ decision? c. What would happen to​ Arbuckle's stock price upon the announcement of this​ change? a. Absent any other trading frictions or​ news, what will its share price be just after the dividend is​ paid? Absent any other trading frictions or​ news, the share price just after the dividend is paid is ​$nothing . ​(Round to the nearest​ cent.)

Homework Answers

Answer #1

Part a

Effective dividend tax rate = (dividend tax rate - capital gains tax rate) /(1 - capital gains tax rate)

= (0.42 – 0.30) / (1 – 0.30)

= 0.1714

= 17.14%

Share price after dividend is paid = current price - dividend paid (1 - dividend tax rate)

= $39 – $6 * (1 – 0.1714)

= $34

Part b

Dividend tax = dividend paid x dividend tax rate

= $6 * 0.42

= $2.52

Tax savings = dividend paid (1 - dividend tax rate) x capital gains tax rate

= $6 (1 - 0.42)* 0.30

= $1.04

Net tax savings = Dividend tax - tax savings

= $2.52 - $1.04

= $1.48

Part C

New stock price= current trading price + net tax savings

= $30 + $1.48

= $31.48

New stock price is increased

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