National Business Machine Co. (NBM) has $2 million of extra cash after taxes hav

Question

National Business Machine Co. (NBM) has $2 million of extra cash after taxes have been paid. NBM has two choices to make use of this cash. One alternative is to invest the cash in financial assets. The resulting 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 2 percent or a 4 percent preferred stock. IRS regulations allow the company to exclude from taxable income 70 percent of the dividends received from investing in another company's stock. Another alternative is to pay out the cash now as dividends. This would allow the shareholders to invest on their own in Treasury bills with the same yield, or in preferred stock. The corporate tax rate is 36 percent. Assume the investor has a 32 percent personal income tax rate, which is applied to interest income and preferred stock dividends. The personal dividend tax rate is 15 percent on common stock dividends. Suppose the company reinvests the $2 million and pays a dividend in three years. What is the total aftertax cash flow to shareholders if the company invests in T-bills? (Enter your answer in dollars, not millions of dollars, i.e. 1, 234, 567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) Value in three years $ What is the total aftertax cash flow to shareholders if the company invests in preferred stock? {Enter your answer in dollars, not millions of dollars, i.e. 1, 234, 567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) Value in three years $ Suppose instead that the company pays a $2 million dividend now and the shareholder reinvests the dividend for three years. What is the total aftertax cash flow to shareholders if the shareholder invests in T-bills? (Enter your answer in dollars, not millions of dollars, i.e. 1, 234, 567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) Value in three years $ What is the total aftertax cash flow to shareholders if the shareholder invests in preferred stock? (Enter your answer in dollars, not millions of dollars, i.e. 1, 234, 567.) Do not round intermediate calculations and round your final answer to 2 decimal places, (e.g., 32.16)) Value in three years $

Explanation / Answer

Ans.:)

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IV) Bit :)

Year 1 Total Investment 2000000 Interest received{ (2000000) * 2%} 40000 Tax @ 36% 14400 Net income 25600 Year 2 Interest received{ (2000000+25600) * 2%} 40512 Tax @ 36% 14584.32 Net income 25927.68 Year 3 Interest received{ (2000000+25600+25928) * 2%} 41031 Tax @ 36% 14771.16 Net income 26259.84 Total Amount held by company at the end of 3 rd year- 2077788 (i.e 2000000+25600+25928+26260) Share holders cash flow after tax Total amount received from company 2077788 Less : Personal dividend tax on common stock @ 15% 311668.2 After tax cash flow to the share holders ------- 1766120

ii) Bit :

Year 1 Total Investment 2000000 Preferred Dividend Received is (2000000 * 4 %) 80000 Less : Exempted income @70% 56000 Taxable Income 24000 Less : Tax @ 36% 8640 Net taxable income--------------------------------------- 15360 Income available for investment (80000-8640) 71360 Year 2 Total Investment (2000000+71360) 2071360 Preferred Dividend Received is{ (2000000+71360) * 4 %} 82854 Less : Exempted income @70% 57998 Taxable Income 24856 Less : Tax @ 36% 8948 Net taxable income--------------------------------------- 15908 Income available for investment (82854-8948) 73906 Year 3 Total Investment (2000000+71360+73906) 2145266 Preferred Dividend Received is{ (2000000+71360+73906) * 4 %} 85811 Less : Exempted income @70% 60067 Taxable Income 25743 Less : Tax @ 36% 9268 Net taxable income--------------------------------------- 16476 Income received (85811-9268) 76543 Total Amount held by company at the end of 3 rd year- 2221809 (i.e 2000000+71360+73906+76543) Share holders cash flow after tax Total amount received from company 2221809 Less : Personal dividend tax on common stock @ 15% 333271 After tax cash flow to the share holders ------- 1888538

III) Bit:

Year 1 Total Amount received from company 2000000 Less ; Personal Dividend Tax @ 15% 300000 Net Amount available for investment by shareholders 1700000 Total Investment 1700000 Interest received{ (1700000) * 2%} 34000 Tax @ 32% 10880 Net income 23120 Year 2 Interest received{ (1700000+23120) * 2%} 34462 Tax @ 32% 11028 Net income 23434 Year 3 Interest received{ (1700000+23120+23434) * 2%} 34931 Tax @ 32% 11178 Net income 23753 Total cash flow held by shareholder at the end of 3 rd year- 1770307 (i.e 1700000+23120+23434+23753)

IV) Bit :)

Year 1 Total Amount received from company 2000000 Less ; Personal Dividend Tax @ 15% 300000 Net Amount available for investment by shareholders 1700000 Total Investment 1700000 Preferred Dividend Received is (1700000 * 4 %) 68000 Tax @ 32% 21760 Net income 46240 Year 2 Preferred Dividend Received is{ (1700000+46240) * 4%} 69850 Tax @ 32% 22352 Net income 47498 Year 3 Preferred Dividend Received is{ (1700000+46240+47498) * 4%} 71750 Tax @ 32% 22960 Net income 48790 Total cash flow held by shareholder at the end of 3 rd year- 1842528 (i.e 1700000+46240+47498+48790)

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