Dividend policy and company value: You purchased 2,000 shares of Ace-IT several years ago at $50 per share. The company does not pay a regular cash dividend. You want to manufacture your own dividend by selling a little bit of shares each quarter. The company's shares are currently trading at $75. If capital gains are taxed at 15 per cent, how many shares would you have to sell to receive $3,420 in cash?
A) 27 shares
B) 46 shares
C) 48 shares
D) 51 shares

Question

Quizplus · Accepted Answer

The total amount of cash required is $3,420. To determine how many shares need to be sold, we need to first find the cost basis of the shares.

The cost basis for 2,000 shares at $50 per share is $100,000 (2,000 x $50). Since no regular cash dividend is paid, we can assume that the entire value of the investment is due to capital appreciation.

To receive $3,420 in cash, we need to sell $3,420 / (1 - 0.15) = $4,023 worth of shares (after-tax).

Thus, $4,023 / $75 per share = 53.64 shares need to be sold to generate the desired amount of cash. Since we can only sell whole shares, we need to sell at least 48 shares (43 shares would generate only $3,225, which is less than the desired amount). Therefore, the best choice is C) 48 shares.

Dividend Policy and Company Value: You Purchased 2,000 Shares of Ace-IT