The Smith Brothers Pharmaceutical Company Has $250,000 in Excess Cash

question 38

Essay

The Smith Brothers Pharmaceutical Company has $250,000 in excess cash and is considering two alternatives. One is to pay the extra cash in the form of a dividend to their stockholders. The other is to invest the cash in a Tbill paying 5% interest after tax, and then distribute the cash as a dividend. The firm's stockholders can also invest in the Tbill for the same yield. If the corporate tax rate is 30% and the personal tax rate is 30%, which alternative would you recommend? (Show why!) If the personal tax rate was 40% what should you recommend?

---

Definitions:

Identifiable Good

A distinct item of personal property that can be recognized individually, as opposed to being a fungible part of a larger quantity.

Gift Irrevocable

A gift that, once given, cannot be taken back or annulled by the donor.

Inter Vivos

Latin for "between the living," refers to actions or gifts made during one's lifetime, as opposed to those made upon death.

Certificate Of Title

An official document that declares the legal owner of a piece of property, such as a vehicle or real estate.