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Pretax Required Return

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The Gecko Company and the Gordon Company are two firms whose business risk is the same but they have different dividend policies. Gecko pays no dividends and Gordon has an expected dividend yield of 6 percent. Suppose the capital gains tax rate is zero, whereas the dividend tax rate is 35 percent. Gecko has an expected earnings growth rate of 15 percent annually, and its stock price is expected to grow at this same rate. If the after tax expected returns on the two stocks are equal (because they are in the same rick class), what is the pretax required return on Gordon's stock?

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Solution Summary

The solution calculates the pretax required return on Gordon's stock.

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Dividend tax rate = 35%
Expected stock price growth, Gecko = 15%
Thus, this is the required pretax rate of return on Gecko's stocks as an ...

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