A. MC Corporation has assets with a market value of $800 million, $50 million of which are excess cash. It has debt of $300 million, and 20 million shares outstanding. The board of directors of the firm has just announced that it will use the excess cash to pay a cash dividend. Suppose that the capital gain tax rate is 25% and the dividend tax rate is 20%. Assume that there are no other market imperfections except taxes.

(i) What is the effective dividend tax rate? Explain the meaning of this effective dividend tax rate in relation to the dollar amount of the cash dividend and the dollar amount of equivalent capital gain income.

(ii) What is the minimum ex-dividend stock price for an investor who could gain from trading to capture the dividend?

(iii) An investor purchased 2000 shares of Waytt Oil several days before the dividend announcement date at the price of $24 per share. If the investor firmly predicts that the ex-dividend price is $22 per share and takes some transactions to benefit from the investor's prediction, what is the net profit (that is, the net income after all taxes) of this investors?

Answer rating: 100% (QA)

i To calculate the effective dividend tax rate we need to consider the combined impact of both capital gains tax and dividend tax on the aftertax retu... View the full answer