Investors require an after-tax rate of return of 10% on their stock investments.

Question

Investors require an after-tax rate of return of 10% on their stock investments. Assume that the tax rate on dividends is 30% while capital gains escape taxation. A firm will pay a $4 per share dividend 1 year from now, after which it is expected to sell at a price of $36. a. Find the current price of the stock. (Do not round intermediate calculations. Round your answer to 2 decimal places.) Current price b. Find the expected before-tax rate of return for a 1-year holding period. (Do not round intermediate calculations. Round your answers to 2 decimal places.) Before-tax rate of return Now suppose that the dividend will be $8 per share. If the expected after-tax rate of return is still 10%, and investors still expect the stock to sell at $36 in 1 year, at what price must the stock now sell? (Do not round intermediate calculations. Round your answer to 2 decimal places.) C. Price d-1. What is the before-tax rate of return? (Do not round intermediate calculations. Round your answer to 2 decimal places.) Before-tax rate of return Why is it now higher than in part (b)? The before-tax return is higher because the d-2. (Click to select) dividend creates a (Click to select) ax burden.

Explanation / Answer

Answer a) Price = PV (after tax dividend plus final share) = (4x(1-0.30) + 36) / 1.10 = 35.27

Answer b) Befor tax rate of return = dividend + gain / price = 4 + (36 - 35.27) / 35.27 =0.134021 or 13.40%

Answer c) Price = PV (after tax dividend plus final share) = (8x(1-0.30) + 36) / 1.10 = 37.8181

Answer d-1)  Befor tax rate of return = dividend + gain / price = 8 + (36 - 35.27) / 35.27 = 0.247423 or 24.73%

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