Question

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

Payola board should consider all of these three consideration separately and it should then make decisions accordingly as per recommendation as follows-

A. When 85% of the shareholders are younger, they would look for more capital appreciation than dividend in nature so dividend is generally associated with people with older age who want an uniform rate of return from the company and who are highly risk averse so according to this criteria it should be decided against payment of dividend.

B. The average tax rate of shareholders is higher than other shareholders, then the dividend payment would be taxed at a higher rate and hence it should instead be reinvested into the profits of the company because it will lead to higher profits overall when the investor will sell his share so according to this criteria also, it should be decided against payment of dividend.

C. When the government is planning to reduce the tax on capital gains and the current rate applicable to ordinary dividend is higher than the capital gains tax then it should be advisable not to issue dividend because investor would be taxed at a higher rate.

After consideration of all three criterias it can be said that it should be decided against the payment of dividend because of higher taxes and lower near-term advantages.