7. Tax Considerations

7.1. A1: Reinvest and Pay Dividend Later

If the firm reinvests, it earns the rate of return of ROICC, which is subject to a corporate income tax rate of τC. The after-tax return on the reinvested capital, therefore, is 6.82%:

 

\( \text{After-tax ROIC}_C = ROIC_C \times ( 1 - \tau_C) = 0.11 \times ( 1-0.38) = 0.0682 \)

 

With an excess cash balance of 100'000 today, the amount that is available for distribution in one year, therefore, is:

 

\( \text{Cash}_1 = \text{Cash}_0 \times ( 1 + \text{After-tax ROIC}_C) = 100'000 \times 1.0682 = 106'820 \) 

 

  

For each dollar the firm returns as dividends, shareholders pay a qualified dividend tax rate (τD) of 15%. Consequently, after personal taxes, the alternative to reinvest the money inside the firm and then distribute the proceeds as a dividend yields the shareholders a net payout of 90'797:

   

\( \text{After-tax Dividend}_1 = \text{Cash}_1 \times (1-\tau_D) = 106'820 \times (1-0.15) = 90'797 \)

 

In sum, a specific excess cash balance (Cash0) that is reinvested for dividend payment in one year yields an after-tax payment to shareholders of:

  

\( \text{After-tax Payout}_\text{Reinvest, Dividend} = \text{Cash}_0 \times (1+ ROIC_C \times (1-\tau_C)) \times (1-\tau_D) \)