ProblemSet(PayoutPolicy)_Upd1.docx

# A assuming 2008 tax rates what would you prefer sell

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a. Assuming 2008 tax rates, what would you prefer -- sell now or wait? b. Suppose the capital gains tax rate is 20% and the dividend tax rate is 40%, what would you prefer now -- sell now or wait? a. In 2008, the capital gains tax rate is 15%, and the dividend tax rate is 15%. If he you sell now, you will have to pay the tax on a \$10 capital gain ( which is \$1.50). If you receive special dividend you will have to pay the tax on a \$10 special dividend (which is also \$1.50). Thus , if ex-dividend price is anything different from \$40, you will have to pay more taxes or receive tax credit, which will make you not indifferent. Alternatively: If you sell now you will get: 50-(50-40)*0.15 If you wait and sell ex-dividend you will get: 10*(1-0.15)+P ex +(P ex -40)*0.15 To be indifferent the two values must be the same: 50-(50-40)*0.15 = 10*(1-0.15)+P ex - (P ex -40)*0.15 From here you can find that P ex = 40 b. If the capital gains tax rate is 20%, the tax on a \$10 capital gain is \$2.00, and the after-tax income is \$8.00. If the dividends tax rate is 40%, then the tax on a \$10 special dividend is \$4.00, and the after-tax income is \$6.00. If you sell now: 50-2 = 48 If you sell ex-dividend: 6+P ex -(P ex -40)*0.2 You will be indifferent when: 48= 6+P ex -(P ex -40)*0.2 P ex = 42.5

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8. At current tax rates, which of the following investors are most likely to hold a stock that has a high dividend yield: a. Individual investors? b. Pension funds? c. Mutual funds? d. Corporations? d. Corporations 9. Que Corporation pays a regular dividend of \$1 per share. Typically, the stock price drops by \$0.80 per share when the stock goes ex-dividend. Suppose the capital gains tax rate is 20%, but investors pay different tax rates on dividends. Absent transactions costs, what is the highest dividend tax rate of an investor who could gain from trading to capture the dividend? Shareholders will be indifferent between trading out of the dividend and doing nothing if the following no-arbitrage condition holds P 1 τ d ( ¿¿ cum P ex ) × ( 1 τ g )= ¿ × ¿ ¿ ) In the LHR of the equation we have after-tax capital loss that the investor would realize if he/she buys the stock at P cum price (in order to capture the dividend) and sells it back at P ex price. Capital loss reduces total taxable income, and total tax bill the investor owes is lower as a result. That is why effective / after-tax capital loss is ( 1 τ g ) smaller than P ( ¿¿ cum P ex ) ¿ . P ( ¿¿ cum P ex ) ¿ is the price drop associated with payment of the dividend. It is equal to 0.8 in this problem. In the RHS we have after-tax dividend that the investor would get if he/she trades to capture the dividend. If after-tax dividend is greater than after-tax capital loss, it makes sense for the investor to trade to capture the dividend. Let us plug numbers into the above equation: 0.8*(1 - 0.2) = \$1 *(1- τ d ) τ d = 0.36 At 36% dividend tax rate an investor would be indifferent between trading to capture the dividend and doing nothing. Investors who pay a lower tax rate than 36% could gain from a dividend capture strategy.
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• Spring '14
• Brown,M
• Dividend tax

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