QUESTION 1

Omicron Technologies made a before-tax profit of $50 million this year. The firm has no debt and 10 million shares outstanding, with a current market price of $45 per share. Its unlevered cost of capital is 10%. Omicron's board is meeting to decide whether to pay out the entire $50 million as a dividend or to use it to repurchase shares of the firm's stock in the open market.

(a) If Omicron uses the entire $50 million to pay a dividend today, what is Omicrons ex-dividend price of the shares in a perfect capital market with no taxes?

(b) If Omicron instead chooses to use the entire $50 million to repurchase shares, what is the number of shares outstanding following the repurchase? What is the price of the shares, in a perfect capital market with no taxes,once the repurchase is complete?

(c) Suppose that Omicrons board decides to pay a dividend today. Now assume that Omicron pays corporate taxes of 30%. The marginal tax rate for shareholders is 35%. What is the after-tax dividend and effective tax rate for shareholders:

Under a classical tax system?

Under an imputation system (assuming that the dividend is 70% franked)?