Suppose that there are just three types of investors with the following tax rates:
| Individuals | Corporations | Institutions |
Dividends | 50% | 5% | 0% |
Capital gains | 15 | 35 | 0 |
Individuals invest a total of $80 billion in stock and corporations invest $10 billion. The remaining stock is held by the institutions. All three groups simply seek to maximize their after-tax income.
These investors can choose from three types of stock offering the following pretax payouts:
| Low Payout | Medium Payout | High Payout |
Dividends | $5 | $5 | $30 |
Capital gains | 15 | 5 | 0 |
These payoffs are expected to persist in perpetuity. The low-payout stocks have a total market value of $100 billion, the medium-payout stocks have a value of $50 billion, and the high-payout stocks have a value of $120 billion.
a. Who are the marginal investors that determine the prices of the stocks?
b. Suppose that this marginal group of investors requires a 12% after-tax return. What are the prices of the low-, medium-, and high-payout stocks?
c. Calculate the after-tax returns of the three types of stock for each investor group.
d. What are the dollar amounts of the three types of stock held by each investor group?
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