Melissa Tang has recently sold her stake in Global Manufacturing Ltd., a firm that she founded in 1990, for $15 million. She is now trying to decide how best to invest the proceeds to support her during her retirement. Following a preliminary conversation with her investment advisor, she is considering investing them in a portfolio consisting of one-year Government of Canada treasury bills, the bonds of Gardner Company, and the shares of Anderson Inc. Recognizing that taxes will represent a significant expense, she is interested in how they might differ between the two different types of investments, debt and equity. To this end, she has asked you to determine the taxes that she might reasonably expect to pay on the two investments recommended by the advisor.
As a first step, you have determined that Melissa's marginal federal tax rate is 29% and her marginal provincial tax rate is 17%. You have also determined that the gross up on eligible dividends is 41%, the dividend tax credit is 16.44% of the grossed-up amount, and the provincial tax rate on eligible dividends is 11.5% of the actual dividend.
a. The shares of Anderson Inc. are currently selling for $2.50 and paid a dividend of $0.20 per share last year. The investment advisor has informed Melissa that these dividends should increase by 5% this year and that the shares should be trading at a price of $3.00 in one year's time. Assuming that the investment advisor's beliefs turn out to be true, what is the total tax that Melissa will have to pay if she invests $2,500 in the shares of Anderson today and sells them in one year's time?
b. The bonds of Gardner Company are currently priced to yield 8%, carry a coupon rate of 6% payable semi-annually, and have 10 years remaining until maturity. Based on anticipated changes in interest rates, the advisor believes that the bonds will be selling for $95 in one year's time. Assuming that the investment advisor's beliefs turn out to be true, what is the total tax that Melissa will have to pay if she purchases 25 $100 face value bonds of Gardner Company today and sells them in one year's time?
c. If Melissa decides to invest $4 million in one-year treasury bills that offer a 3% yield, $5 million in the bonds of Gardner Company and $6 million in the shares of Anderson Inc., what is the expected after-tax rate of return on her selected investment portfolio?