# Stock Price- Dividends, Taxes, Capital Gain

Dividends and Taxes:

Investors require an after-tax rate of return of 10 percent on their stock investments. Assume that the tax rate on dividends is 30 percent while capital gains escape taxation.

A firm will pay a $2 per share dividend 1 year from now, after which it is expected to sell at a price of $20.

a. Find the current price of the stock.

b. Find the expected before-tax rate of return for a 1-year holding period.

c. Now suppose that the dividend will be $3 per share. If the expected after-tax rate of return is still 10 percent, and investors still expect the stock to sell at $20 in 1 year, at what price must the stock now sell?

d. What is the before-tax rate of return? Why is it now higher than in part (b)?

https://brainmass.com/business/accounting/stock-price-dividends-taxes-capital-gain-134706

#### Solution Preview

Investors require an after-tax rate of return of 10 percent on their stock investments. Assume that the tax rate on dividends is 30 percent while capital gains escape taxation.

A firm will pay a $2 per share dividend 1 year from now, after which it is expected to sell at a price of $20.

a. Find the current price of the stock.

Let the current price be Po

Capital gains= $20-Po

Dividends= $2.00

Tax on capital gains= 0%

Tax on dividends= 30%

Thus after tax returns= ($20-Po) + (1-0.3)x $2= ($20-Po) + $ 1.40=

The investors demand 10% return on their stock investment

Therefore 10% x Po = ($20-Po) + $ 1.40

or 1.1 Po = $ 21.40

or Po= $21.40 / 1.1 = $19.45

Answer: Current stock ...

#### Solution Summary

The solution calculates the stock price and expected before-tax rate of return for a 1-year holding period