Question

Chapter 14 - Dividends and Dividend Policy Saved AS aiscussea in tne text, in tne apsence or market imperrections ana tax erects, we would expect the share price to decline by the amount of the dividend payment when the stock goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price: 2 (Po-PxID= (1- TA/(1-Td Skipped where Po is the price just before the stock goes ex, Px is the ex-dividend share price, D is the amount of the dividend per share, Tp is the relevant marginal personal tax rate on dividends, and TG is the effective marginal tax rate on capital gains. If Tp= TG= 0, how much will the share price fall when the stock goes ex? b. If Tp 15 percent and 7TG 0, how much will the share price fall? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) c. If Tp 15 percent and if TG-30 percent, how much will the share price fall? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g. 32.1616.) d. Suppose the only owners of stock are corporations. Recall that corporations get at least an 80 percent exemption from taxation on the dividend income they receive, but they do not get such an exemption on capital gains. If the corporation's income and capital gains tax rates are both 21 percent, what does this model predict the change in the ex-dividend share price will be? (Do not round intermediate calculations and round your answer to 4 decimal places, e.g., 32.1616.) a. Share price decline a. b. Share price decline D Share price decline D C. d. Share price decline

Answer 1

Part (a)

(P0 - PX) / D = (1 - 0) / (1 - 0) = 1

Hence, P0 - Px = Decline in price = D = 1D

Hence please enter 1 in the first answer box.

Part (b)

(P0 - PX) / D = (1 - 15%) / (1 - 0) = 0.85

Hence, P0 - Px = Decline in price = D = 0.85D

Hence please enter 0.85 in the first answer box.

Part (c)

(P0 - PX) / D = (1 - 15%) / (1 - 30%) = 0.85/ 0.7 = 1.2143

Hence, P0 - Px = Decline in price = D = 1.2143D

Hence please enter 1.2143 in the first answer box.

Part (d)

(P0 - PX) / D = [1 - 21% x (1 - 80%)] / (1 - 21%) = 0.85/ 0.7 = 1.2127

Hence, P0 - Px = Decline in price = D = 1.2127D

Hence please enter 1.2127 in the first answer box.