Question

Investors require a 10% aftertax return for investing in shares. The dividends are taxed at 28% and capital gains are not taxed at all. The expected value for the shares of Omega in one year is $20 and the expected dividend is $2.

a- Determine the present value of this share.

b- Consider the case in which Omega pays out a $3 cash dividend per share. If the expected return after tax is still 10% and investors are waiting to sell the shares at $19 within a year, determine the present value of the share.

Answer 1

Given that,

Investor requires a return of 10%

Dividend are taxed at 28%

Year end price P1 = $20

Expected dividend = $2

a). So, dividend received after paying tax D1 = 2*(1-0.28) = $1.44

For a return of 10%, present value = (P1 + D1)/(1+r) = (20+1.44)/1.1 = $19.49

So, present value of share is $19.49

b). when

Year end price P1 = $19

Expected dividend = $3

So, dividend received after paying tax D1 = 3*(1-0.28) = $2.16

For a return of 10%, present value = (P1 + D1)/(1+r) = (19 + 2.16)/1.1 = $19.24

So, present value of share is $19.24