After completing its capital spending for the year, Carlson Manufacturing has $1

Question

After completing its capital spending for the year, Carlson Manufacturing has $1,300 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 7 percent or paying out the cash to investors who would invest in the bonds themselves.

If the corporate tax rate is 32 percent, what personal tax rate would make the investors equally willing to receive the dividend or to let Carlson invest the money? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

Suppose the only investment choice is a preferred stock that yields 10 percent. The corporate dividend exclusion of 70 percent applies. What personal tax rate will make the stockholders indifferent to the outcome of Carlson’s dividend decision? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places (e.g., 32.16).)

After completing its capital spending for the year, Carlson Manufacturing has $1,300 extra cash. Carlson’s managers must choose between investing the cash in Treasury bonds that yield 7 percent or paying out the cash to investors who would invest in the bonds themselves.

Explanation / Answer

a. If personal tax would be equal to corporate tax rate then it will make the investors equally willing to receive the dividend or to let Carlson invest the money. Therefore, Personal tax rate = 32%

b. Yes the answer in (a) is reasonable.

c. Interest a company is earning = 1300*10% = $130
Tax which a company has to pay = 130*(1-0.70)*32% = $12.48
Indifferent Personal Tax rate = 12.48*100/130 = 9.6%
Therefore, if the personal tax rate will be equal to 9.6% then the stockholders will become indifferent to the outcome of Carlson’s dividend decision.

d. Yes, if personal tax rate would be equal to corporate tax rate then the company is not required to pay the dividend, thus, a low payout ratio.

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