Question #17 - Reading 15 Analysis of Dividends and Share Repurchases

Reading: Reading 15 Analysis of Dividends and Share Repurchases

PDF File: Reading 15 Analysis of Dividends and Share Repurchases.pdf

Page: 8

Status: Unattempted

Correct Answer: A

Shared Context

- Which of the following dividend policy is consistent with the Rainham Inc.'s proposed dividend policy of setting an initial dividend payout ratio to 30% and then increase this over the following five years to 70%? A) Residual dividend model. B) Dividend stability. C) Target payout ratio.

Question

Rainham Inc. pays 35% taxes based on the U.S. tax laws and pays a dividend of $0.90 a share. Assuming that the investor who receives Rainham Inc.'s dividend is in the 15% tax bracket. The effective tax rate on a dollar of earnings paid out as dividends will be:

Answer Choices:

A. Higher than 35%

B. Equal to the investor’s tax bracket of 15%

C. Equal to the corporate tax rate of 35%

Explanation

U.S. tax rules are based on a double taxation system. As such, the effective tax rate will be higher than just the corporate tax rate of 35% as taxes paid would include both corporate tax and the tax paid on the dividend.

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