Clark Industries faces a choice between paying out $150 million cash through a share repurchase, and investing the $150 million in Treasury securities paying 5 interest for one year If shareholders are paid the cash through a share repurchase they are going to invest it in the same T securities as Clark would If Clark retains and invests cash it is going to pay the entire investment income out to shareholders in the form of dividends Assume that corporate tax rate is 40 and investors pay 20 tax rate on dividends and capital gains and 30 on interest income (6 points) What would shareholders want Clark to do with the cash Explain, provide computations (2 points) Now suppose that Clark plans an expansion project next year If the company retains the cash it would not need to raise new funds from outside investors for the project Find the amount of effective fees, F , at which Clark is indifferent between retaining the cash and paying it out (4 points) Raising new funds costs F dollars, nominal issuance fees The fees expense is tax deductible If F $2 5M should Clark retain or payout the $150M now

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Posted on Oct 03, 2024

Clark Industries faces a choice between paying out $150 million cash through a share repurchase, and investing the $150 million in Treasury securities paying 5%

Clark Industries faces a choice between

paying out $150 million cash through a share repurchase, and
investing the $150 million in Treasury securities paying 5% interest for one year.

If shareholders are paid the cash through a share repurchase they are going to invest it in the same T-securities as Clark would. If Clark retains and invests cash it is going to pay the entire investment income out to shareholders in the form of dividends.

Assume that corporate tax rate is 40% and investors pay 20% tax rate on dividends and capital gains and 30% on interest income.

(6 points) What would shareholders want Clark to do with the cash? Explain, provide computations.
(2 points) Now suppose that Clark plans an expansion project next year. If the company retains the cash it would not need to raise new funds from outside investors for the project. Find the amount of effective fees, F*, at which Clark is indifferent between retaining the cash and paying it out.
(4 points) Raising new funds costs F dollars, nominal issuance fees. The fees expense is tax deductible. If F=$2.5M should Clark retain or payout the $150M now?