Corporate_Finance_9th_edition_Solutions_Manual_FINAL0

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Unformatted text preview: s(t EPS1 – Div0) Div1 = $1.50 + .3[(.4)($4.15) – $1.50] Div1 = $1.548 b. Now we use an adjustment rate of 0.60, so the dividend next year will be: Div1 = Div0 + s(t EPS1 – Div0) Div1 = $1.50 + .6[(.4)($4.15) – $1.50] Div1 = $1.596 c. The lower adjustment factor in part a is more conservative. The lower adjustment factor will always result in a lower future dividend. Challenge 17. Assuming no capital gains tax, the aftertax return for the Gordon Company is the capital gains growth rate, plus the dividend yield times one minus the tax rate. Using the constant growth dividend model, we get: Aftertax return = g + D(1 – t) = .12 Solving for g, we get: .12 = g + .06(1 – .35) g = .0810 The equivalent pretax return for Gecko Company, which pays no dividend, is: Pretax return = g + D = .0810 + .06 = 14.10% 18. Using the equation for the decline in the stock price ex-dividend for each of the tax rate policies, we get: (P0 – PX)/D = (1 – TP)/(1 – TG) a. P0 – PX = D(1 – 0)/(1 – 0) P0 – PX = D 405 b. c. d. P0 – PX = D(1 – .15)/(1 – 0) P0 – PX = .85D P0 – PX = D(1 – .15)/(1 – .20) P0 – PX = 1.0625D With this tax policy, we simply need to multiply the personal tax rate times one minus the dividend exemption percentage, so: P0 – PX = D[1 – (.35)(.30)]/(1 – .35) P0 – PX = 1.3769D e. Since different investors have widely varying tax rates on ordinary income and capital gains, dividend payments have different after-tax implications for different investors. This differential taxation among investors is one aspect of what we have called the clientele effect. 19. Since the $3,000,000 cash is after corporate tax, the full amount will be invested. So, the value of each alternative is: Alternative 1: The firm invests in T-bills or in preferred stock, and then pays out as a special dividend in 3 years If the firm invests in T-Bills: If the firm invests in T-bills, the aftertax yield of the T-bills will be: Aftertax corporate yield = .05(1 – .35) Aftertax corporate yield = .0325 or 3.25% So, the future value of the corporate investment in T-bills will be: FV of investment in T-bills = $3,000,000(1 + .0325)3 FV of investment in T-bills = $3,302,109.23 Since the future value will be paid to shareholders as a dividend, the aftertax cash flow will be: Aftertax cash flow to shareholders = $3,302,109.23(1 – .15) Aftertax cash flow to shareholders = $2,806,792.85 If the firm invests in preferred stock: If the firm invests in preferred stock, the assumption would be that the dividends received will be reinvested in the same preferred stock. The preferred stock will pay a dividend of: Preferred dividend = .07($3,000,000) Preferred dividend = $210,000 Since 70 percent of the dividends are excluded from tax: Taxable preferred dividends = (1 – .70)($210,000) 406 Taxable preferred dividends = $63,000 And the taxes the company must pay on the preferred dividends will be: Taxes on preferred dividends = .35($63,000) Taxes on preferred dividends = $22,050 So, the aftertax dividend for the corporation will be: Aftertax corporate dividend = $210,000 – 22,050 Aftertax corporate dividend = $187,950 This means the aftertax corporate dividend yield is: Aftertax corporate dividend yield = $187,950 / $3,000,000 Aftertax corporate dividend yield = .0627 or 6.27% The future value of the company’s investment in preferred stock will be: FV of investment in preferred stock = $3,000,000(1 + .0627)3 FV of investment in preferred stock = $3,599,912.91 Since the future value will be paid to shareholders as a dividend, the aftertax cash flow will be: Aftertax cash flow to shareholders = $3,599,912.91(1 – .15) Aftertax cash flow to shareholders = $3,059,925.97 Alternative 2: The firm pays out dividend now, and individuals invest on their own. The aftertax cash received by shareholders now will be: Aftertax cash received today = $3,000,000(1 – .15) Aftertax cash received today = $2,550,000 The individuals invest in Treasury bills: If the shareholders invest the current aftertax dividends in Treasury bills, the aftertax individual yield will be: Aftertax individual yield on T-bills = .05(1 – .31) Aftertax individual yield on T-bills = .0345 or 3.45% So, the future value of the individual investment in Treasury bills will be: FV of investment in T-bills = $2,550,000(1 + .0345)3 FV of investment in T-bills = $2,823,135.12 407 The individuals invest in preferred stock: If the individual invests in preferred stock, the assumption would be that the dividends received will be reinvested in the same preferred stock. The preferred stock will pay a dividend of: Preferred dividend = .07($2,550,000) Preferred dividend = $178,500 And the taxes on the preferred dividends will be: Taxes on preferred dividends = .31($178,500) Taxes on preferred dividends = $55,335 So, the aftertax preferred dividend will be: Aftertax preferred dividend = $178,500 – 55,335 Aftertax preferred dividend = $123,165 This means the aftertax individual dividend yield is: Aftertax corporate dividend yield = $123,165 / $2,550,000 Aftertax corporate dividend yield = .0483 or 4.83% The f...
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This note was uploaded on 07/10/2010 for the course FIN 6301 taught by Professor Eshmalwi during the Spring '10 term at University of Texas-Tyler.

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