Question

A financial analyst is evaluating two potential uses of corporate cash received from selling a division. A special dividend of $8 per share could be paid to the shareholders of the 2 million shares of stock. Alternatively, the cash could be used to repurchase shares of the corporation’s stock at the current stock price of $80 per share. The analyst assumes that the average income tax rate that investors would pay on the dividends is 30%, and the average income tax rate the investors would pay on the capital gains of repurchased stock is 20%. In addition, the analyst assumes that the owners of the repurchased stock paid an average of $50 per share for the stock. When comparing the two possible uses of the cash, the analyst concluded that taxes paid on the special dividend would be

Answer 1

The taxes paid on the special dividend would be $5.60 per share.

Step-by-step explanation:

The analyst concluded that taxes paid on the special dividend would be $5.60 per share.

To calculate the taxes paid on the special dividend, we multiply the dividend amount by the average income tax rate. In this case, the dividend amount is $8 per share and the average income tax rate is 30%. So, the taxes paid on the special dividend would be $8 x 30% = $2.40 per share.

However, since the dividend is taxable income for the shareholders, we need to deduct the taxes from the dividend amount to calculate the after-tax dividend. So, the after-tax dividend would be $8 - $2.40 = $5.60 per share.