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After completing its capital spending for the year, Carlson Manufacturing has $1,000 extra cash. Carlson's managers must choose between investing the cash in Treasury bonds
After completing its capital spending for
the year, Carlson Manufacturing has $1,000 extra cash. Carlson's managers must
choose between investing the cash in Treasury bonds that yield 3 percent or paying
the cash out to investors who would invest in the bonds themselves.
a. If the corporate tax rate is 21 percent, what personal tax rate would make the inves-
tors equally willing to receive the dividend or to let Carlson invest the money?
b. Is the answer to part (a) reasonable? Why or why not?
c. Suppose the only investment choice is preferred stock that yields 6 percent. The
corporate dividend exclusion of 50 percent applies. What personal tax rate will
make the stockholders indifferent to the outcome of Carlson's dividend decision?
d. Is this a compelling argument for a low dividend payout ratio? Why or why not?
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