Use the following information to answer the question(s)below.
d'Anconia Copper has $200 million in cash that it can use for a share repurchase.Suppose instead that d'Anconia Copper invests the funds in an account paying 5% interest for one year.Assume that the corporate tax rate is 21%,the individual capital gains rate is 15% and the individual rate on ordinary income is 32%.
-Net of capital gains taxes,the amount the total value of d'Anconia Copper shares increase is closest to:
A)$6.7 million.
B)$6.5 million.
C)$7.0 million.
D)$10.0 million.

Question

Quizplus · Accepted Answer

If d'Anconia Copper uses the $200 million for a share repurchase, the increase in share value would be $200 million minus taxes. Assuming a total tax rate of 36% (21% corporate tax and 15% capital gains tax), the net increase in share value would be $200 million x (1-36%) = $128 million.

If d'Anconia Copper invests the $200 million in an account paying 5% interest for one year, the before-tax return would be $200 million x 5% = $10 million. After taxes, the net return would be $10 million x (1-21%) x (1-15%) = $7.355 million.

The net increase in share value from investing the $200 million would be $7.355 million, which is less than the net increase in share value from a share repurchase. Therefore, the best choice would be for d'Anconia Copper to use the $200 million for a share repurchase.

The closest option to the net increase in share value from a share repurchase is $6.7 million, which is option A.

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