If the board chooses to pay a dividend, what is the ex-dividend price of the shares in a perfect capital market with no taxes? If the board instead chooses to use the cash to do a one-time share repurchase, in a perfect capital market with no taxes, what is the price of the shares once the repurchase is complete? Suppose that the board decides to pay a dividend. Now assume that Braxton Enterprises pays corporate taxes of 30% and the marginal tax rate for shareholders is 40%. What is the after-tax dividend and effective tax rate for shareholders:
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
Braxton Enterprises has made a before-tax profit of $300 million. The firm has no debt and 100 million shares outstanding, with a current market price of $15 per share. Braxton’s board is currently deciding whether to pay out this profit to shareholders through a dividend or a one-time share repurchase.
- If the board chooses to pay a dividend, what is the ex-dividend price of the shares in a perfect capital market with no taxes?
- If the board instead chooses to use the cash to do a one-time share repurchase, in a perfect capital market with no taxes, what is the price of the shares once the repurchase is complete?
- Suppose that the board decides to pay a dividend. Now assume that Braxton Enterprises pays corporate taxes of 30% and the marginal tax rate for shareholders is 40%. What is the after-tax dividend and effective tax rate for shareholders:
- Under a classical tax system?
- Under an imputation system (assuming that the dividend is 70% franked)?
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