In 2014 the median starting salaries of male and female Australian bachelor degree accounting graduates aged less than 25 years in their first full-time industry job was $50,000 before tax, according to Graduate Careers Australia. See page 9 of this report. 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 $50,000 per annum before-tax?
Question 494 franking credit, personal tax on dividends, imputation tax system
A firm pays a fully franked cash dividend of $100 to one of its Australian shareholders who has a personal marginal tax rate of 15%. The corporate tax rate is 30%.
What will be the shareholder's personal tax payable due to the dividend payment?
Due to floods overseas, there is a cut in the supply of the mineral iron ore and its price increases dramatically. An Australian iron ore mining company therefore expects a large but temporary increase in its profit and cash flows. The mining company does not have any positive NPV projects to begin, so what should it do? Select the most correct answer.
Excess cash flows that are one-off are best paid out using special dividends or buy-backs because shareholders do not expect them to happen again.
Corporate managers would not usually increase the regular dividend if they thought that they would have to decrease it again later, because it sends mixed signals to shareholders. Increasing the regular dividend is likely to signal to shareholders that the company will have permanently higher dividends. When the regular dividend would need decreasing later, shareholders would be disappointed.
A pharmaceutical firm has just discovered a valuable new drug. So far the news has been kept a secret.
The net present value of making and commercialising the drug is $200 million, but $600 million of 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 bond raising to shareholders simultaneously in the same announcement. The bonds will be issued shortly after.
Once the announcement is made and the bonds are issued, what is the expected increase in the value of the firm's assets (ΔV), market capitalisation of debt (ΔD) and market cap of equity (ΔE)?
The triangle symbol 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: ##ΔV = ΔD+ΔE##
Since the project has a positive NPV of $200m, the value of the firm's assets (V) must increase by $200m. Assuming that the debt can be fully paid off, this positive $200m NPV will all accrue to the equityholders since they have a residual claim on the firm's assets.
The project will be funded by issuing bonds which will add $600m to debt liabilities (D) and cash or equipment assets (V).
Therefore, ##ΔV=800m, ΔD = 600m, ΔE=200m##.
Question 513 stock split, reverse stock split, stock dividend, bonus issue, rights issue
Which of the following statements is NOT correct?
A rights issue is a capital raising, not a payout.
A '3 for 10 rights issue at a subscription price of $8' means that for every 10 existing shares, all shareholders can buy 3 extra shares from the company at a price of $8 each, so shareholders pay money.
A company conducts a 4 for 3 stock split. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order.
To find the change in the stock price, remember that the stock split creates no wealth for shareholders, and no money changes hands between shareholders and the company.
###\text{WealthBefore} = \text{WealthAfter} ### ###n_0.P_0 = n_1.P_1 ### ###3 \times P_0 = 4 \times P_1 ### ###\dfrac{P_1}{P_0} = \dfrac{3}{4} ###To find the proportional change in the stock price from the stock split:
###\begin{aligned} r_P &= \dfrac{P_1 - P_0}{P_0} \\ &= \dfrac{P_1}{P_0} - 1\\ &= \dfrac{3}{4} - 1\\ &=-0.25 \\ \end{aligned}###The 4 for 3 stock split will:
- Decrease the share price by 25%;
- Increase the number of shares by 33.33% ##(=1/3)##.
- Cause no change in the market capitalisation of equity.
Question 566 capital structure, capital raising, rights issue, on market repurchase, dividend, stock split, bonus issue
A company's share price fell by 20% and its number of shares rose by 25%. Assume that there are no taxes, no signalling effects and no transaction costs.
Which one of the following corporate events may have happened?
The number of shares rose by 25%. There couldn't have been a cash dividend since it creates no new shares. It couldn't have been a buyback either since it reduces the number of shares.
The 1 for 5 bonus issue results in a 20% ##(=1/5)## increase in the number of shares, not 25%, so that's not an option.
Both the 5 for 4 stock split and the 1 for 4 rights issue will increase the number of shares by 25% ##(=1/4)##. They are both potential answers.
The stock price fall in the rights issue can be calculated:
###\text{WealthBefore} = \text{WealthAfter} ### ###\text{SharesBefore} + \text{CashToBuyNewShares} = \text{SharesAfter} ### ###n_0.P_0 + C_0 = n_1.P_1 ### ###4 \times 5 + 1 \times 3 = (4 + 1) \times P_1 ### ###P_1 = 23/5 = 4.6###To find the proportional change in the stock price from the rights issue:
###\begin{aligned} r_P &= \dfrac{P_1 - P_0}{P_0} \\ &= \dfrac{4.6 - 5}{5} \\ &=-0.08 \\ \end{aligned}###This is not equal to the 20% price fall stated in the question.
Therefore the stock split must be the correct option. To find the change in the stock price, remember that the stock split creates no wealth for shareholders and pays no money to or from the shareholders or company.
###\text{WealthBefore} = \text{WealthAfter} ### ###n_0.P_0 = n_1.P_1 ### ###4 \times P_0 = 5 \times P_1 ### ###\dfrac{P_1}{P_0} = \dfrac{4}{5} ###To find the proportional change in the stock price from the stock split:
###\begin{aligned} r_P &= \dfrac{P_1 - P_0}{P_0} \\ &= \dfrac{P_1}{P_0} - 1\\ &= \dfrac{4}{5} - 1\\ &=-0.2 \\ \end{aligned}###In mid 2009 the listed mining company Rio Tinto announced a 21-for-40 renounceable rights issue. Below is the chronology of events:
- 04/06/2009. Share price opens at $69.00 and closes at $66.90.
- 05/06/2009. 21-for-40 rights issue announced at a subscription price of $28.29.
- 16/06/2009. Last day that shares trade cum-rights. Share price opens at $76.40 and closes at $75.50.
- 17/06/2009. Shares trade ex-rights. Rights trading commences.
All things remaining equal, what would you expect Rio Tinto's stock price to open at on the first day that it trades ex-rights (17/6/2009)? 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 16/06/2009, $75.50.
Let a shareholder with 40 shares and $594.09 ##(=28.29 \times 21)## in the bank to 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 ### ###40 \times 75.50 + 21 \times 28.29 = (40 + 21) \times P_1 ### ###P_1 = 59.2473###Question 455 income and capital returns, payout policy, DDM, market efficiency
A fairly priced unlevered firm plans to pay a dividend of $1 next year (t=1) which is expected to grow by 3% pa every year after that. The firm's required return on equity is 8% pa.
The firm is thinking about reducing its future dividend payments by 10% so that it can use the extra cash to invest in more projects which are expected to return 8% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $0.90. No new equity or debt will be issued to fund the new projects, they'll all be funded by the cut in dividends.
What will be the stock's new annual capital return (proportional increase in price per year) if the change in payout policy goes ahead?
Assume that payout policy is irrelevant to firm value (so there's no signalling effects) and that all rates are effective annual rates.
The firm is fairly priced, so its required return (cost of capital) of 8% must equal its expected return (or internal rate of return). Since the new projects' risks are the same as the old projects, the required return must also be 8%.
###r_\text{total, new} = r_\text{total, old} = 0.08###The new projects' expected return is 8% too, so the new projects must be fairly priced, therefore they have a zero net present value. Another way of looking at this is that the cost of capital (total required return or deserved return) equals the internal rate of return (expected return) therefore the NPV is zero.
The share price must not change since the NPV of the projects is zero and there is no new money raised or paid by the firm. Also, payout policy is irrelevant to firm value. So the new share price ##P_{0, \text{new}}## must equal the old share price ##P_{0, \text{old}}##. The old 3% growth rate in the dividend must be equal to the old growth rate in the share price which is the old capital return ##P_\text{capital old}##, according to the theory of the perpetuity equation. Applying the perpetuity with growth formula:
###\begin{aligned} P_{0, \text{new}} &= P_{0, \text{old}} \\ &= \dfrac{C_\text{1 old}}{r_\text{total old} - r_\text{capital old}} \\ &= \dfrac{1}{0.08 - 0.03} \\ &= 20 \\ \end{aligned}###The new dividend ##C_\text{1 new}## will be only $0.90, so the new long term capital return in the perpetuity formula can be calculated:
###\begin{aligned} P_{0, \text{new}} &= \dfrac{C_\text{1 new}}{r_\text{total new} - r_\text{capital new}} \\ 20 &= \dfrac{0.9}{0.08 - r_\text{capital new}} \\ \end{aligned}### ###\begin{aligned} r_\text{capital new} &= 0.08 - \dfrac{0.9}{20} \\ &= 0.08 - 0.045 \\ &= 0.035 \\ \end{aligned}###This new 3.5% pa growth rate in the dividends is also the long term capital return of the stock. Therefore the stock price should increase 3.5% each year, faster than the old 3% pa rate. This makes sense since the firm is re-investing more money and should be able to generate higher growth in assets, dividends and the stock price.
Note that the instantaneous capital return is zero since there was no price-sensitive news released, just a change in payout policy. All of the new projects that will be invested in have zero NPV. So there is no reason for the stock price to increase straightaway.