a) The increase in Kay's equity value would be 0.15 x 200, or $30,000,000.
b) On the tax-dividend rate of the one-time dividend, the value of Kay stock would decline by $200,000,000.
c) Given these price movements, the decision will net investors $30 million in profit.
The tax advantage is the term used to describe the economic benefit that is given to some investments or accounts that are, by law, tax-free, tax-deferred, or tax-reduced. Retirement plans, college savings accounts, medical savings accounts, and government bonds are a few examples of tax-advantaged accounts and investments.
a) Calculation of Tax Advantage:
Tax Disadvantage = [1 - (1 - Corporate Tax Rate) * (1 - Dividend Tax Rate)] / [1 - Tax rate on Interest]
Tax Disadvantage = [1 - (1 - 0.40) * (1 - 0.15)] / [1 - 0.40}
Tax Disadvantage = [1 - (0.60 * 0.85)] / 0.6
Tax Disadvantage = (1 - 0.51) / 0.6 = 0.49 / 0.6 = 1 - 0.85 = 0.15
Therefore, Tax Disadvantage = 0.15.
Kay's equity value would rise by 0.15 * 200 = $30,000,000.
b) It would decrease by $200,000,000. Because tax rates on dividends and capital gains are equal, the effective dividend tax rate is 0.
c) Given these price reactions, this choice will result in a $30 million profit for investors.
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