Question

An investor has a 38 percent ordinary income tax rate and a 20 percent long-term capital gains tax rate. The investor holds stock in a firm that could pay its usual $1 per share dividend or reinvest the cash in the firm. The stock price is currently $30 per share. If the firm does not pay the dividend, the share price will rise. If it pays the dividend, the share price will stay the same. By how much must the share price rise if the dividend is not paid in order to make the investor indifferent between receiving the dividend or not?A. $0.97B. $1.00C. $0.78D.$0.50E. $0.59

Answer 1

Answer:

Change in share price required  = $0.775 = $0.78

so correct option is C. $0.78

Explanation:

given data

ordinary income tax rate = 38 %

long-term capital gains tax rate = 20 %

dividend or reinvest = $1 per share

stock price = $30 per share

solution

we can say that when investor receive the dividend tax each dollar is = $0.38

so  net realization will be

net realization = $1 - $0.38

net realization = $0.62

and here if not pay dividend keep retained earning

then gain in share price 20% capital gains tax

so now  Net Realization will be

Change in share price required  = $\frac{net\ realization}{1 - 20%}$

Change in share price required  = $\frac{0.62}{0.80}$

Change in share price required  = $0.775 = $0.78

so correct option is C. $0.78