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Dividends and Taxes

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

Stock Expected Dividend Expected Capital Gain
STOCK EXPECTED DIVIDEND EXPECTED CAPITAL GAIN
A $0 $10
B 5 5
C 10 0

a. If each stock is priced at $100, what are the expected net returns on each stock to (i) a pension fund that does not pay taxes, (ii) a corporation paying tax at 35 percent, and (iii) an individual with an effective tax rate of 15 percent on dividends and 10 percent on capital gains?

b. Suppose that investors pay 50 percent tax on dividends and 20 percent tax on capital gains. If stocks are priced to yield an 8 percent return after tax, what would A, B, and C each sell for?

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Solution Summary

This solution calculates the expected net returns of three stocks when sold.

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