The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $80,204.80 assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:
| Taxable income | Tax on this income |
|---|---|
| 0 – $18,200 | Nil |
| $18,201 – $37,000 | 19c for each $1 over $18,200 |
| $37,001 – $80,000 | $3,572 plus 32.5c for each $1 over $37,000 |
| $80,001 – $180,000 | $17,547 plus 37c for each $1 over $80,000 |
| $180,001 and over | $54,547 plus 45c for each $1 over $180,000 |
The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations
How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?
Question 449 personal tax on dividends, classical tax system
A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.
The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.
The United States' classical tax system applies because the company generates all of its income in the US and pays corporate tax to the Internal Revenue Service. The shareholder is also an American for tax purposes.
What will be the personal tax payable by the shareholder and the corporate tax payable by the company?
The corporate tax payable is very simple:
###\begin{aligned} \text{CorporateTaxPayable } &= \text{ProfitBeforeTax}.t_c \\ &= 100 \times 0.3 \\ &= 30 \\ \end{aligned}###Therefore the profit after tax is $70 and it's all paid as a fully franked dividend. The shareholder's personal tax payable will be:
###\begin{aligned} \text{PersonalTaxPayable } &= \text{CashDiv}.t_p \\ &= 70 \times 0.45 \\ &= 31.5 \\ \end{aligned}###Notice that the total tax payable is $61.5. The dividends were double-taxed at the corporate and personal level which is always the case in classical tax systems such as in the United States. Note however that in the US corporate and personal tax rates are lower than in Australia.
Question 624 franking credit, personal tax on dividends, imputation tax system, no explanation
Which of the following statements about Australian franking credits is NOT correct? Franking credits:
No explanation provided.
Question 448 franking credit, personal tax on dividends, imputation tax system
A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner.
The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%.
The Australian imputation tax system applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability.
What will be the personal tax payable by the shareholder and the corporate tax payable by the company?
The corporate tax payable is very simple:
###\begin{aligned} \text{CorporateTaxPayable } &= \text{ProfitBeforeTax}.t_c \\ &= 100 \times 0.3 \\ &= 30 \\ \end{aligned}###Therefore the profit after tax is $70 and it's all paid as a fully franked dividend. The shareholder's personal tax payable will be:
###\begin{aligned} \text{PersonalTaxPayable } &= \text{GrossedUpDiv}.t_p - \text{FrankingCredit} \\ &= \dfrac{\text{CashDiv}}{1-t_c}.t_p - \dfrac{\text{CashDiv}}{1-t_c}.t_c \\ &= \dfrac{70}{1-0.3} \times 0.45 - \dfrac{70}{1-0.3} \times 0.3 \\ &= 45 - 30 \\ &= 15 \\ \end{aligned}###Notice that the total tax payable is $45, which is 45% of the original pre-tax earnings of the firm. This is the aim of the imputation system: for the sum of corporate and personal tax to equal the individual shareholder's personal marginal rate which in this case is 45%. This way dividends are not double-taxed as they are in classical tax systems such as in the United States.
A company announces that it will pay a dividend, as the market expected. The company's shares trade on the stock exchange which is open from 10am in the morning to 4pm in the afternoon each weekday. When would the share price be expected to fall by the amount of the dividend? Ignore taxes.
The share price is expected to fall during the:
The stock price will fall overnight between the market close (4pm in Australia) on the last with-dividend date and the market open (10am in Australia) on the ex-dividend date. This is because the dividend will only be paid to the shareholder who owns the share when the market closes on the last with-dividend date.
The dividend payment date is irrelevant. A share holder who held the share on the close of the last with-dividend date could sell the share before the dividend payment date and would still be paid the dividend.
Currently, a mining company has a share price of $6 and pays constant annual dividends of $0.50. The next dividend will be paid in 1 year. Suddenly and unexpectedly the mining company announces that due to higher than expected profits, all of these windfall profits will be paid as a special dividend of $0.30 in 1 year.
If investors believe that the windfall profits and dividend is a one-off event, what will be the new share price? If investors believe that the additional dividend is actually permanent and will continue to be paid, what will be the new share price? Assume that the required return on equity is unchanged. Choose from the following, where the first share price includes the one-off increase in earnings and dividends for the first year only ##(P_\text{0 one-off})## , and the second assumes that the increase is permanent ##(P_\text{0 permanent})##:
Note: When a firm makes excess profits they sometimes pay them out as special dividends. Special dividends are just like ordinary dividends but they are one-off and investors do not expect them to continue, unlike ordinary dividends which are expected to persist.
First find the required total return on equity (r) using the DDM:
###P_\text{0, old} = \frac{C_1}{r-g} ### ###6 = \frac{0.5}{r-0} ### ###\begin{aligned} r &= \frac{0.5}{6} \\ &=1/12 = 0.083333333 \\ \end{aligned}###If investors believe that the high level of profits and dividends is a one-off event, then the share price will increase by the present value of the single extra cash flow. The new share price will be:
###\begin{aligned} P_\text{0 one-off} &= P_\text{0,old} + \frac{C_\text{1,new one-off}}{(1+r)^1} \\ &= 6 + \frac{0.30}{(1+0.083333333 )^1} \\ &=6.276923077 \\ \end{aligned}###On the other hand, if investors believe that the high level of profits and dividends will be permanent, then the share price will increase by the present value of the perpetuity of cash flows. The new share price will be:
###\begin{aligned} P_\text{0 permanent} &= P_\text{0,old} + \frac{C_\text{1,new permanent}}{r-g} \\ &= 6 + \frac{0.30}{0.083333333 - 0} \\ &= 6 + 3.60 \\ &= 9.60 \\ \end{aligned}###Or another method:
###\begin{aligned} P_\text{0 permanent} &= \frac{C_\text{1,old} + C_\text{1,new permanent}}{r-g} \\ &= \frac{0.5+0.30}{0.083333333 - 0} \\ &= 9.60 \\ \end{aligned}###A mining firm has just discovered a new mine. So far the news has been kept a secret.
The net present value of digging the mine and selling the minerals is $250 million, but $500 million of new equity and $300 million of new bonds will need to be issued to fund the project and buy the necessary plant and equipment.
The firm will release the news of the discovery and equity and bond raising to shareholders simultaneously in the same announcement. The shares and bonds will be issued shortly after.
Once the announcement is made and the new shares and bonds are issued, what is the expected increase in the value of the firm's assets ##(\Delta V)##, market capitalisation of debt ##(\Delta D)## and market cap of equity ##(\Delta E)##? Assume that markets are semi-strong form efficient.
The triangle symbol ##\Delta## is the Greek letter capital delta which means change or increase in mathematics.
Ignore the benefit of interest tax shields from having more debt.
Remember: ##\Delta V = \Delta D+ \Delta E##
Since the project has a positive NPV of $250m, the value of the firm's assets (V) must increase by $250m. Assuming that the debt can be fully paid off, this positive $500m NPV will all accrue to the equity holders (E) since they have a residual claim on the firm's assets.
The project will be funded by issuing $500m of equity and $300m of bonds which will all be received in cash (an asset) and then spent on equipment (also an asset). This capital raising will cause assets (V) to rise by $800m, plus the $250m NPV as well, totaling $1,050m. Similarly, the increase in equity will be the sum of the capital raising and positive-NPV events, totaling $750m.
Therefore, ##\Delta V = 1,050m##, ##ΔD = 300m##, ##ΔE= 750##.
Question 568 rights issue, capital raising, capital structure
A company conducts a 1 for 5 rights issue at a subscription price of $7 when the pre-announcement stock price was $10. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order. Ignore all taxes, transaction costs and signalling effects.
Since the rights issue is a zero-sum game, the shareholders' wealth before (t=0) the rights issue must be equal to their wealth after (t=1). Presume a shareholder with 5 shares and $7 in the bank participates in the rights issue:
###\text{WealthBefore} = \text{WealthAfter} ### ###\text{SharesBefore} + \text{CashToBuyNewShares} = \text{SharesAfter} ### ###n_0.P_0 + C_0 = n_1.P_1 ### ###5 \times 10 + 1 \times 7 = (5 + 1) \times P_1 ### ###P_1 = 57/6 = 9.5###To find the proportional change in the stock price:
###\begin{aligned} r_P &= \dfrac{P_1 - P_0}{P_0} \\ &= \dfrac{9.5 - 10}{10} \\ &=-0.05 \\ \end{aligned}###To find the proportional change in the number of stocks:
###\begin{aligned} r_n &= \dfrac{n_1 - n_0}{n_0} \\ &= \dfrac{(5+1) - 5}{5} \\ &= 6/5 = 0.2 \\ \end{aligned}###Question 625 dividend re-investment plan, capital raising
Which of the following statements about dividend re-investment plans (DRP's) is NOT correct?
If all shareholders participated in the DRP, it is true that there would be no dividend payments but there would be lots of new shares issued which will result in a share price fall. The share price fall from issuing new shares without payment to the company is sometimes called dilution. Shareholder wealth would be unaffected since the fall in share price will be offset by the higher number of shares owned.
In late 2003 the listed bank ANZ announced a 2-for-11 rights issue to fund the takeover of New Zealand bank NBNZ. Below is the chronology of events:
- 23/10/2003. Share price closes at $18.30.
- 24/10/2003. 2-for-11 rights issue announced at a subscription price of $13. The proceeds of the rights issue will be used to acquire New Zealand bank NBNZ. Trading halt announced in morning before market opens.
- 28/10/2003. Trading halt lifted. Last (and only) day that shares trade cum-rights. Share price opens at $18.00 and closes at $18.14.
- 29/10/2003. Shares trade ex-rights.
All things remaining equal, what would you expect ANZ's stock price to open at on the first day that it trades ex-rights (29/10/2003)? Ignore the time value of money since time is negligibly short. Also ignore taxes.
Since the rights issue is a zero-sum game, the shareholders' wealth before (t=0) the rights issue must be equal to their wealth after (t=1).
The market price of the stock just before the rights issue ex-date was the closing price on 28/10/2003, $18.14.
Let a shareholder with 11 shares and $26 ##(=13 \times 2)## in the bank participate in the rights issue:
###\text{WealthBefore} = \text{WealthAfter} ### ###\text{SharesBefore} + \text{CashToBuyNewShares} = \text{SharesAfter} ### ###n_0.P_0 + C_0 = n_1.P_1 ### ###11 \times 18.14 + 2 \times 13 = (11 + 2) \times P_1 ### ###P_1 = 17.3492###Note that the value of one right (to buy one share) can be estimated by finding the difference between the forecast ex-rights market price and the subscription price:
###\begin{aligned} \text{ValueOfOneRight} &= \text{ExRightsMarketPrice} - \text{SubscriptionPrice} \\ &= 17.3492- 13 \\ &= 4.3492 \\ \end{aligned}###This $4.3492 estimate was quite close to the actual value of one right which was $3.60 according to ANZ bank's media release on 28 November 2003. The reason it's slightly different is likely due to news between 23 October and 28 November 2003 which affected the market index and the ANZ share price.