You are the only stockholder of F, which is all equity.

Your personal tax rate on dividends is 40%. You must choose between

1. Paying out a special dividend for a total amount of $1,000,000. After taxes, you invest this dividend in another firm G that has the same systematic risk as F, share price $1 and pays out a dividend of d every year.
2. Investing $1 million in a project P that generates additional EBIT (= operating cash-flows) of $500,000 per year (perpetuity). The after-tax earnings from the project is paid out in dividend every year. F's corporate tax rate TC is 30%.

What is the smallest d such that you prefer (a) to (b)?

Answer rating: 100% (QA)

To determine the smallest value of d such that you prefer option a over option b we need to compare ... View the full answer