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 $28
B 14 14
C 28 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%, and (iii) an individual with an effective tax rate of 15% on dividends and 10% on capital gains?
Stock Pension Investor
Corporation Individual
A % % %
B % % %
C % % %
b.Suppose that investors pay 50% tax on dividends and 20% tax on capital gains. If stocks are priced to yield an 10% return after tax, what would A, B, and C each sell for? Assume the expected dividend is a level perpetuity.
Stock P0
A $
B
C