Section__7_Solutions

# Section__7_Solutions - Section#7 Ex-Dividend Stock Pricing...

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Section #7 Ex-Dividend Stock Pricing and Stock Market Indices March 31st and April 1st, 2009 Copyright 2009 by Rich Curtis

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1. Ex-Dividend Stock Pricing
a. If P s,c is the cum-dividend (Monday) price and P s,x is the ex-dividend (Tuesday) price, then your expected profit is given by: E Profit = -P s,c + (D + P s,x ) = -\$25 + (\$1 + \$24) = \$0

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b. If t d is the tax rate on dividends, and t stg is the tax rate on short-term gains, then: E Profit = (1-t stg )(-P s,c + P s,x ) + (1-t d )D = (1-.386)(-\$1) + (1-.386)(+\$1) = \$0
c. If t c is the corporate tax rate then: E Profit = (1-t c )(-P s,c + P s,x ) + ( D - t c [.3D] ) = (1-.35)(-\$1) + ( \$1 - [(.35)(.3)(\$1)] ) = -\$.65 + (\$1 - \$.105) = -\$.65 + \$.895 = \$.245

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d. If P s,cost is your cost basis per share and t ltg is the tax rate on long-term capital gains and losses, the after-tax cash flow from a Monday sale is: P s,c - t ltg ( P s,c - P s,cost ) The after-tax cash flow from a Tuesday sale is: (1- t d )D + P s,x - t ltg ( P s,x - P s,cost )
Equating the 2 expressions, we have: P s,c - t ltg ( P s,c - P s,cost ) = (1-t d )D + P s,x - t ltg ( P s,x - P s,cost ) P s,c - P s,x - t ltg ( P s,c - P s,cost - P s,x + P s,cost ) = (1-t d )D (1 - t ltg )( P s,c - P s,x ) = (1-t d )D P s,c - P s,x D = 1-t d 1 - t ltg

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If t d = .386 and t ltg = .20, then: Is there any empirical support for this result? P s,c - P s,x D = 1-t d 1 - t ltg = 1-.386 1-.20 = .7675
If you expect the ex-dividend price drop to be more than this equilibrium amount, then: Sell cum-dividend (Monday) because your after-tax proceeds will be higher. If you expect the ex-dividend price drop to be less than this equilibrium amount, then: Sell ex-dividend (Tuesday) because your after-tax proceeds will be higher.

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If t d = .15 and t ltg = .15, then: In words, the investor will be indifferent between closing out his(her) position cum–dividend or ex–dividend if the ex–dividend stock price drop is 100% of the amount of the dividend. e. P s,c - P s,x D = 1-t d 1 - t ltg = 1-.15 1-.15 = 1
The well-known result expressed as was derived by Elton and Gruber (1970) and is given in problem #18 (pp. 602-603) of Chapter 18 of Ross, Westerfield, and Jordan ( 2006 ) with the only difference being that RWJ use P o instead of P s,c , P x instead of P s,x , t o instead of t d , and t g instead of t ltg . P s,c - P s,x D = 1- t d 1 - t ltg

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2. Market Indices
1. Consider the common stocks of the 3 companies listed below. Calculate the total market value of each firm’s equity and write that value in the last column: Outstanding Share Total Company Shares Price Equity Value Cayuga Consulting (CC) 32 Million \$12 Finger Lakes Tours (FLT) 4 Million \$48 Keuka-Made Boating (KMB) 2 Million \$81 A. Price-Weighted Averages \$384 Million \$192 Million \$162 Million Market Cap

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2. The Cornell Industrial Average (CIA) is calculated by adding up
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## This note was uploaded on 09/03/2009 for the course AEM 3240 taught by Professor Curtis,r. during the Spring '07 term at Cornell.

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Section__7_Solutions - Section#7 Ex-Dividend Stock Pricing...

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