Question

You manage a (tax-free) pension fund that is invested in KOA Corporation. KOA's managers have just announced that they unexpectedly generated an extra $50 million in cash flow this year. They are considering paying it out now as a special dividend or investing it in one-year Treasury securities that will earn 1.0% interest over the next year. They would then distribute the $50 million plus interest earned as a special dividend. If OA pays a 35% corporate tax rate, would you prefer they pay the $50 million as a special dividend now or wait a year? If KOA pays the special dividend immediately, you can then choose to invest in the same one-year Treasury securities and earn Smillion. (Round to two decimal places.) If KOA invests in the one-year Treasury securities, they will have to pay taxes and so will only be able to pay out $million. (Round to two decimal places.) Thus, you would prefer they pay the $50 million as a special dividend .(Select from the drop-down menu.)

Answer 1

The tax implications should be considered when deciding whether to pay a special dividend now or wait a year. In this scenario, since the after-tax amounts are the same in both scenarios, it doesn't matter whether KOA Corporation pays the special dividend now or wait a year.

Step-by-step explanation:

When deciding whether to pay a special dividend now or wait a year, it is important to consider the tax implications. If KOA Corporation pays the $50 million as a special dividend now, they would need to pay a 35% corporate tax rate on the amount. However, if they invest it in one-year Treasury securities, they would earn 1.0% interest over the next year and pay taxes on the total amount, including the interest earned. To determine which option is preferable, we can calculate the after-tax amounts for each scenario.

If KOA pays the special dividend immediately, the after-tax amount would be calculated as $50 million - (35% * $50 million) = $32.5 million. If KOA Corporation invests in the one-year Treasury securities, the after-tax amount would be $50 million * (1 - 35%) = $32.5 million.

Since the after-tax amounts are the same in both scenarios, it doesn't matter whether KOA Corporation pays the special dividend now or wait a year. Therefore, you would prefer they pay the $50 million as a special dividend now.