The most likely tax environment in which Wilson Paper’s shareholders would prefer that Wilson repurchase its shares (share buybacks) instead of paying dividends is one in which:

Janet Wu is treasurer of Wilson Paper Company, a manufacturer of paper products
for the office and school markets. Wilson Paper is selling one of its divisions for $70 million
cash. Wu is considering whether to recommend a special dividend of $70 million or a
repurchase of 2 million shares of Wilson common stock in the open market. She is reviewing
some possible effects of the buyback with the company’s financial analyst. Wilson has a longterm record of gradually increasing earnings and dividends. Wilson’s board has also approved
capital spending of $15 million to be entirely funded out of this year’s earnings.
Book value of equity $750 million ($30 a share)
Shares outstanding 25 million
12-month trading range $25–$35
Current share price $35
After-tax cost of borrowing 7%
60 Learning Outcomes, Summary Overview, and Problems
part-i-07 13 January 2012; 10:21:1
Estimated full year earnings $25 million
Last year’s dividends $9 million
Target debt/equity (market value) 35/65
A. the tax rate on capital gains and dividends is the same.
B. capital gains tax rates are higher than dividend income tax rates.
C. capital gains tax rates are lower than dividend income tax rates.

Ans: C. capital gains tax rates are lower than dividend income tax rates.