Question

Case study number three, chapter four: the scenario is your company has $5 million in short-term investments. The short-term investments are to be used to expand your facilities. Due to regulatory challenges, though, the expansion will be delayed for 36 months or three years. Your company has asked you to evaluate which of the following investment options they can consider. Assuming that your company is a C Corp with a 21% corporate tax rate here in the US, choose one of these three investment options:

1. Invest in Corporate Bonds yielding 12% per annum pre-tax.
2. Invest in non-dividend paying corporate equities expected to earn 12% per annum pre-tax.
3. Invest in preferred stock of other corporations paying a 10% dividend per year. Dividend will be eligible for the 50% Corporate Dividends Received Deduction.

Answer 1

The recommended investment for the company is in non-dividend paying corporate equities expected to earn 12% per annum pre-tax due to potential tax-efficient capital gains.The correct answer is 2. Invest in non-dividend paying corporate equities expected to earn 12% per annum pre-tax.

Step-by-step explanation:

The most appropriate investment option for the company with $5 million in short-term investments, needing to wait 36 months for expansion, would be to invest in non-dividend paying corporate equities. By investing in equities expected to earn 12% per annum pre-tax, there is potential for capital gains which would only be taxable upon sale.

This can be more tax-efficient, compared to corporate bonds, which yield interest income that is fully taxable annually at the corporate tax rate of 21%. Option 3, while providing a 50% Corporate Dividends Received Deduction, offers a lower pre-tax yield of 10%. Additionally, fluctuations in equity values may give the company a chance to realize higher returns if the market performs well.

Therefore option 2. Invest in non-dividend paying corporate equities expected to earn 12% per annum pre-tax is the correct answer.