Question

Suppose you invest $100,000 in a mutual fund for 10 years. The fund earns 6% pretax per year, makes no annual distributions (and thus there is no income to be taxed each year) and you sell the fund at the end of the 10 years. You pay a 20% tax on capital gains and a 40% tax on ordinary income. What is the pre-tax total dollar accumulation at the end of 10 years? What is the after-tax total dollar accumulation at the end of 10 years? Suppose instead you invest the $100,000 in preferred stock paying 6% per annum with the dividend taxed at 20% per year (as dividends receive their own tax preferred rate). Assume the after-tax dividends are reinvested in the preferred stock. What is the after-tax total dollar accumulation at the end of 10 years? What do you conclude from comparing the above alternatives?

Answer 1