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 $175, 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 45% (the effective tax rate on dividends received by corporations is 10.5%), 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

(A)	Investor	Stock A	Stock B	Stock C
	(i) Pension Fund	=(0+10)/175	=(5+5)/175	=(10+0)/175
	(ii) Corporation	=((0*(1-0.105)+10*(1-0.45))/175)	=((5*(1-0.105)+5*(1-0.45))/175)	=((10*(1-0.105)+0*(1-0.45))/175)
	(iii) Individual	=((0*(1-0.1)+10*(1-0.05))/175)	=((5*(1-0.1)+5*(1-0.05))/175)	=((10*(1-0.1)+0*(1-0.05))/175)
(B)		Stock A	Stock B	Stock C
	Stock Price	=+((0*(1-0.4)+10*(1-0.1))/0.1)	=+((5*(1-0.4)+5*(1-0.1))/0.1)	=+((10*(1-0.4)+0*(1-0.1))/0.1)