It is January 5, 1994 and you plan to buy 1,000 shares in Company ABC and hold them for exactly one year. According to the CAPM, the expected return on ABC equity is 10 percent (pre-personal tax). The current price per share is $30. For now, assume no taxes.
a) ABC will pay a dividend of $2.00 per share next year, where the ex-dividend date is January 5, 1995. What is your total dividend income and expected capital gains income when you sell your shares on January 5, 1995? Keep in mind that you expect the share price to increase by 10 percent, and then drop by the dividend per share at the beginning of January 5, 1995.
Company XYZ is identical to ABC except that it will pay no dividend in the following year.
b) Is your total income (dividends plus expected capital gains) higher if you purchase 1,000 shares in Company XYZ on January 5, 1994 and sell them on January 5, 1995?
Refer to Slide 31 of Week 5. Assume the capital gains tax rate and dividend tax rate that corresponds to January 5, 1995.
c) Calculate the effective dividend tax rate. What is the ex-dividend price per share of ABC?
d) What is your after-tax dividend income and expected after-tax capital gains income for ABC? What about for XYZ? Which stock gives you a higher total income?
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