Question

Suppose that all capital gains are taxed at a 18% rate, and that the dividend tax rate is 36%. Arbuckle Corp. is currently trading for $41, and is about to pay a $6 special dividend a. Absent any other trading frictions or news, what will its share price be just after the dividend is paid? Suppose Arbuckle made a surprise announcement that it would do a share repurchase rather than pay a special dividend. b. What net tax savings per share for an investor would result from this decision? c. What would happen to Arbuckle's stock price upon the announcement of this change?

Answer 1

Ans:- (a) As per question the Arbuckle corp. is currently trading at $41 and is about to pay a special dividend of $6. capital gains are taxed at 18% and the dividend is taxed at 30%. therefore to calculate the share price after the dividend is paid we will first  calculate the capital gain tax rate

Therefore the capital gain tax rate will be (36%-18%)/(1-18%)=0.18/0.82 = 0.2195 =21.95%.

Now to calculate the share price after the announcement of the dividend will be given by Price = Current stock price - Dividend(1- Tax rate) = 41 - 6(1-0.2195) = $36.30.

Ans -(b) From the above scenario it is obvious that the stock price falls from $41 to $36.31 and hence capital loss has occurred after the announcement. The capital loss here is 41-36.30=4.7

Now calculating the tax on dividends is 36% of $6 i.e 2.16

Now calculating the tax on capital loss 18% of $4.7 i.e 0.846.

Now the total net savings per share of the investor will be (2.16-0.846)= $1.314.

Ans -(c) After analyzing the above scenario it is obvious that the Arbuckle corporation stock price will increase by $1.314 i.e now the stock price will be $42.314.