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 $105, 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 21%.(the effective tax rate on dividends received by corporations is 6.3%, 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

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

W Q v 1 = ENG 05:14 25-02-2020 25 BS135 X fix BJ B K BL BM BN BO BP BQ BR BS BT BU BV 114 115 116 117 PENSION FUND 118 AS PENSION FUND DOES NOT PAY ANY TAX, WHATEVER BE THE SOURCE OF INCOME, IT IS FULLY TAX FREE STOCK NET INCOME = DIVIDEND + CAPITAL GAIN NET PERCENTAGE RETURNS 10 9.52% 10/105*100 9.52% 10/105*100 10 9.52% 10/105*100 10 CORPORATION 124 CORPORATION PAYS 21% TAX ON CAPITAL GAIN AND 6.3% ON DIVIDEND INCOME SO NET INCOME = CAPITAL GAIN (1-0.21) + DIVIDEND(1-0.063) STOCK NET INCOME NET PERCENTAGE RETURNS = NET INCOME/105*100 10*(1-0.21) + 0*(1-0.063) = 7.52% 5*(1-0.21) + 5*(1-0.063) = 8.22% 0*(1-0.21) + 10(1-0.063) = 8.92% 127 128 INDIVIDUAL 130 131 132 INDIVIDUAL PAYS 10% ON DIVIDENDS AND 5% ON CAPITAL GAIN SO NET INCOME = CAPITAL GAIN (1-0.05) + DIVIDEND(1-0.1) STOCK NET INCOME NET PERCENTAGE RETURNS = NET INCOME/105*100 10"(1-0.05) + 0*(1-0.1) = 9.05% B 5*(1-0.05) + 5*(1-0.1) = 8.81% 0*(1-0.05) + 10*(1-0.1) = 8.57% 135 136 137 ... FCF ARM, MSI.confidenceINDEX LOAN CURRENCY CROSS OVER GM HPRAM TAX HEDGING MONEY MARKET GROWTH SUST PREF AND DIV POLICY ... :

v 4* ENG 05:14 25-02-2020 25 X fix BS160 2 137 138 BI BJ B K BL BM BN BO BP BQ BR BS BT BU BV STOCK 142 PENSION CORPORATION 9.52% 7.52% 9.52% 8.22% 9.52% 8.92% 23. INDIVIDUAL 9.05% 8.81% 8.57% 146 (b) 147 148 149 INVESTOR PAYS TAX EQUAL TO 40% ON DIVIDEND AND 10% ON CAPITAL GAIN AND RETURN ON STOCK AFTER TAX = 10%, PRICE OF STOCK WILL BE = NET RETURN/10% STOCK 152 FORMULA =(0*(1-0.4) + 10*(1-0.1))/0.1 FORMULA =(5*(1-0.4) + 5*(1-0.1))/0.1 FORMULA = (10*(1-0.4) + 0*(1-0.1))/0.1 153 155 157 158 160 ... FCF ARM, MSI.confidenceINDEX LOAN CURRENCY CROSS OVER GM HPRAM TAX HEDGING MONEY MARKET GROWTH SUST PREF AND DIV POLICY ... :