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 ordinary income taxes,the amount that investors would have if they invested the $200 million on their own is closest to:
A)$5.5 million.
B)$6.5 million.
C)$6.8 million.
D)$10.0 million.

Question

Quizplus · Accepted Answer

If d'Anconia Copper invests the $200 million in an account paying 5% interest for one year, the company will have $210 million in cash at the end of the year. However, before distributing any cash to shareholders, the company must pay corporate taxes on its earnings. The corporate tax rate is 21%, so after paying taxes, the company will have:

$210 million × (1 − 0.21) = $166.2 million

Next, if the company distributes the remaining $166.2 million to shareholders through a share repurchase, shareholders will have to pay capital gains taxes on the proceeds. The capital gains tax rate is 15%, so after paying taxes, shareholders will have:

$166.2 million × (1 − 0.15) = $141.27 million

Alternatively, if shareholders had received the $200 million and invested it directly, they would have to pay individual taxes on any earnings. The individual tax rate on ordinary income is 32%, but the interest earned in the account is taxed as investment income, which has a lower tax rate. Let's assume that the investment income tax rate is 21% (the average of the 15% capital gains tax rate and the 32% ordinary income tax rate). After paying taxes, shareholders would have:

$200 million × 1.05 × (1 − 0.21) × (1 − 0.21) = $149.46 million

Therefore, net of ordinary income taxes, the amount that investors would have if they invested the $200 million on their own is $149.46 million - $141.27 million = $8.19 million. However, the question asks for the closest option, which is C) $6.8 million.

Use the Following Information to Answer the Question(s)below