Question

The expected pretax return on three stocks is divided between dividends and capital gains in the following way:

Stock	Expected Dividend	Expected Capital Gain
A	$0	$10
B	5	5
C	10	0

a. If each stock is priced at $145, what are the expected net percentage returns on each stock to (i) a pension fund that does not pay taxes, (ii) a corporation paying tax at 45% (the effective tax rate on dividends received by corporations is 10.5%), and (iii) an individual with an effective tax rate of 10% on dividends and 5% on capital gains? (Do not round intermediate calculations. Enter your answers as a percent rounded to 2 decimal places.)

Stock	Pension		Investor Corporation		Individual
A		%		%		%
B		%		%		%
C		%		%		%

b. Suppose that investors pay 40% tax on dividends and 10% tax on capital gains. If stocks are priced to yield an after-tax return of 10%, what would A, B, and C each sell for? Assume the expected dividend is a level perpetuity. (Do not round intermediate calculations. Round your answers to 2 decimal places.)

Stock	Price
A
B
C

Answer 1

Answer (a)
Return of Dollar =		Dividend(1-DT) + Capital Gain(1-CG tax)
Net Return =		Dollar Return/Price
(Pension)
Stock	Exp. Dividend	Exp. CG	Dividend Tx Rate	CG Tax Rate	Dollar Return	Net Return
A.	0	10	0	0	10	6.897%
B.	5	5	0	0	10	6.897%
C.	10	0	0	0	10	6.897%
(Corporation)
Stock	Exp. Dividend	Exp. CG	Dividend Tx Rate	CG Tax Rate	Dollar Return	Net Return
A.	0	10	10.50%	10.50%	8.95	6.172%
B.	5	5	10.50%	10.50%	8.95	6.172%
C.	10	0	10.50%	10.50%	8.95	6.172%
(Individual)
Stock	Exp. Dividend	Exp. CG	Dividend Tx Rate	CG Tax Rate	Dollar Return	Net Return
A.	0	10	10%	5%	9.5	6.552%
B.	5	5	10%	5%	9.25	6.379%
C.	10	0	10%	5%	9	6.207%
Answer (b)
Price for all the 3 stocks
Price =	Dollar Return / After tax Return
Stock	Exp. Dividend	Exp. CG	Dividend Tx Rate	CG Tax Rate	Dollar Return	Price
A.	0	10	40%	10%	9	90.00
B.	5	5	40%	10%	7.5	75.00
C.	10	0	40%	10%	6	60.00