Assume the corporate tax rate is 22 percent, the personal tax rate on interest income is 15 percent, and the personal tax rate on dividends is 10 percent. Also assume the firm earns $5 per share in taxable income and pays out 40 percent of its earnings. How much will a shareholder receive per share in aftertax income?
Question
Assume the corporate tax rate is 22 percent, the personal tax rate on interest income is 15 percent, and the personal tax rate on dividends is 10 percent. Also assume the firm earns $5 per share in taxable income and pays out 40 percent of its earnings. How much will a shareholder receive per share in aftertax income?
Solution
Step 1: Calculate the corporate tax The firm earns 5 * 22% = $1.1.
Step 2: Calculate the earnings after corporate tax Subtract the corporate tax from the taxable income to get the earnings after corporate tax. So, 1.1 = $3.9 per share.
Step 3: Calculate the dividend The firm pays out 40 percent of its earnings as dividends. So, the dividend per share is 1.56.
Step 4: Calculate the personal tax on dividends The personal tax rate on dividends is 10 percent. So, the personal tax on dividends per share is 0.156.
Step 5: Calculate the after-tax dividend Subtract the personal tax on dividends from the dividend to get the after-tax dividend. So, 0.156 = $1.404 per share.
Step 6: Calculate the retained earnings Subtract the dividend from the earnings after corporate tax to get the retained earnings. So, 1.56 = $2.34 per share.
Step 7: Calculate the personal tax on retained earnings The personal tax rate on interest income is 15 percent. So, the personal tax on retained earnings per share is 0.351.
Step 8: Calculate the after-tax retained earnings Subtract the personal tax on retained earnings from the retained earnings to get the after-tax retained earnings. So, 0.351 = $1.989 per share.
Step 9: Calculate the total after-tax income Add the after-tax dividend and the after-tax retained earnings to get the total after-tax income. So, 1.989 = $3.393 per share.
So, a shareholder will receive $3.393 per share in after-tax income.
Similar Questions
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