Question

6. Payola Company board is deciding whether it should pay a liquidating dividend of $ 50 per share or an equivalent extraordinary annual dividend.
The finance department got the following relevant information for making the decision:
a. 85% of the shareholders are between 30 and 50 years old. The remaining 15% is more than 70 years old.
b. The average tax bracket of Payola’s shareholders is 25% higher than the average of the investors in public companies in the country.
c. The government is planning to reduce the tax rate on capital gains from 25% to 20%. The current tax rate applicable to ordinary dividends is 22%.

Required:
What should Payola Board do? Give specific recommendations, back them up with numbers in a, b, c above

Answer 1

Each and every case should be accessed separately when it comes to assessment of dividend-

A. When there is a very low chunk of its share holder who are old,the need for dividend is not that important because the shareholders who are young will always be look for capital appreciation and shareholders were old are generally focus over dividend.

B. Higher tax bracket of shareholders means that the dividend will be taxable at the higher rates so payment of dividend would not be able to make the desired benefit to the shareholders because of presence of a higher tax percentage so, dividend should not be provided instead it should be reinvested into projects.

C. When the government is planning to reduce the tax rate on capital gains then the dividend tax rate is still higher than that of capital gains tax, so, the decision should be taken against issuance of the dividend as it would also mean a higher rate of tax for the shareholders because capital gains tax are lower than the dividend tax.

So overall, the company should decide against issue of dividend.