Question

1. What should be the current price of a stock, which is expected to be sold for $45 one year from now, pays a dividend of $5, and has an expected after-tax return of 20%? The tax rate on dividends is 40% and the tax rate on capital gains is 20%.

Answer 1

Current Stock Price = $45

Dividend = $5

After Tax Return = 20%

Share Price at the end = Current Stock Price * ( 1 + After Tax return) - Dividend

= 45 * ( 1 +20%) - 5

= $54 - 5

= $49

The share price at the end of the period will be $49.

Note : Dividend Decreases the earnings available to the shareholders thus the market cap reduces and the capital gain and the dividend are chargeable in the income of investors also the after tax return os given, So, It would have no Impact.