Section _8--Indices

# Section _8--Indices - Section #8 Ex-Dividend Stock Pricing...

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Section #8 Ex-Dividend Stock Pricing and Stock Market Indices October 27th, 2010 Copyright 2010 by Rich Curtis

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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 Ρ Σ ΢ Τ Φ Υ = -P s,c + (D + P s,x ) = -\$25 + (\$1 + \$24) = \$0
b. If t d is the tax rate on dividends, and t stg is the tax rate on short-term gains, then: E Profit Ρ Σ ΢ Τ Φ Υ = (1-t stg )(-P s,c + P s,x ) + (1-t d )D = (1-.386)(-\$1) + (1-.386)(+\$1) = \$0

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c. If t c is the corporate tax rate then: E Profit Ρ Σ ΢ Τ Φ Υ = (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
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 )

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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
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

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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.
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

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The well-known result expressed as was derived by Elton and Gruber (1970) and is given in problem #14 (pp. 575-576) of Chapter 17 of Ross, Westerfield, and Jordan ( 2010 ). The only difference is that RWJ use P o instead of P s,c , P x instead of P s,x , t p instead of t d , and t g instead of t ltg . P s,c - P s,x D = 1- t d 1 - t ltg
2. Market Indices

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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
The Cornell Industrial Average (CIA) is calculated by adding up the share prices of the three companies and dividing by three. What is the value of the CIA?

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## This note was uploaded on 09/24/2011 for the course HADM 2225 taught by Professor Wellman, j during the Spring '08 term at Cornell University (Engineering School).

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Section _8--Indices - Section #8 Ex-Dividend Stock Pricing...

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