Consider the following tax rates: In 2006, Luther Incorporated paid a special dividend of $7 per share for the 120 million shares outstanding. If Luther has instead retained that cash permanently and invested it into Treasury bills earning 5%, then the present value (PV)of the additional taxes paid by Luther would be closest to ________.

Question

Consider the following tax rates:  In 2006, Luther Incorporated paid a special dividend of $7 per share for the 120 million shares outstanding. If Luther has instead retained that cash permanently and invested it into Treasury bills earning 5%, then the present value (PV)of the additional taxes paid by Luther would be closest to ________.

Quizplus · Accepted Answer

To calculate the PV of the additional taxes paid by Luther, we need to first calculate the additional taxable income that would result from the dividend being retained and invested in Treasury bills.

120 million shares x $7 per share = $840 million

Retaining this amount and investing in Treasury bills earning 5% would result in annual interest income of:

$840 million x 5% = $42 million

Assuming a tax rate of 35%, the additional taxable income would result in additional taxes paid of:

$42 million x 35% = $14.7 million per year

To find the PV of this stream of additional tax payments, we can use the formula for PV of a growing perpetuity:

PV = (annual payment) / (discount rate - growth rate)

In this case, the annual payment is $14.7 million, the discount rate is the post-tax rate of return on Treasury bills (5% x (1 - 35%) = 3.25%), and the growth rate is the inflation rate (assumed to be 2%).

PV = $14.7 million / (0.0325 - 0.02) = $294 million

Therefore, the answer is C, $294 million.

Consider the Following Tax Rates: in 2006, Luther Incorporated