NBM has $2 million of extra cash. It has two choices to make use of the cash. One alternative is to invest the cash in financial assets. The resulted investment income will be paid out as a special dividend at the end of three years. In this case, the firm can invest in Treasury bills yielding 7%, or an 11% preferred stock. The tax law says only 30% of the dividend from the preferred stock investment would be subject to the corporate income tax. Another alternative is to pay out the cash as dividends and let the shareholders invest on their own in T-bills with the same yield. The corporate tax rate is 35%, and the individual tax rate is 31%. Should the cash be paid today or in three years? Which of the two options generates the highest after-tax income for shareholders?
NBM has $2 million of extra cash. It has two choices to make use of the cash. One alternative is to invest the cash in financial assets. The resulted investment income will be paid out as a special dividend at the end of three years. In this case, the firm can invest in Treasury bills yielding 7%, or an 11% preferred stock. The tax law says only 30% of the dividend from the preferred stock investment would be subject to the corporate income tax. Another alternative is to pay out the cash as dividends and let the shareholders invest on their own in T-bills with the same yield. The corporate tax rate is 35%, and the individual tax rate is 31%. Should the cash be paid today or in three years? Which of the two options generates the highest after-tax income for shareholders?
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:2. NBM has $2 million of extra cash. It has two choices to make use of the
cash. One alternative is to invest the cash in financial assets. The resulted
investment income will be paid out as a special dividend at the end of three
years. In this case, the firm can invest in Treasury bills yielding 7%, or an
11% preferred stock. The tax law says only 30% of the dividend from the
preferred stock investment would be subject to the corporate income
tax. Another alternative is to pay out the cash as dividends and let the
shareholders invest on their own in T-bills with the same yield. The
corporate tax rate is 35%, and the individual tax rate is 31%. Should the
cash be paid today or in three years? Which of the two options generates the
highest after-tax income for shareholders?
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