Chapter 10 Questions
|Price before dividend||Price after dividend||Dividend||Tax on capital gains||Tax on ordinary income|
To calculate the marginal tax rate on stockholders, we use the formula below:
𝑃_𝐵=𝑃𝑟𝑖𝑐𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑃_𝐴=𝑃𝑟𝑖𝑐𝑒 𝑎𝑓𝑡𝑒𝑟 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑡_𝑜=𝑇𝑎𝑥 𝑜𝑛 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑖𝑛𝑐𝑜𝑚𝑒
𝑡_𝑐𝑔=𝑇𝑎𝑥 𝑜𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛𝑠
Substituting the known values:
Re-arranging to make 𝑡_𝑜 the subject of the formula:
|Question 3||Capital Gains Rate||50%|
|Price Before Dividend||Price After Dividend||Dividend||Tax on Capital Gains||(1+R)||(1+R)^n||Number of years||Ordinary Tax Rate||50%|
First, calculate the effective capital gain rate:
Effective capital gains rate=(Stated capital gains rate)/(1+R)^n
n=Number of periods
Substituting the known values into the formula:
Effective capital gains rate=0.5/(1+0.1)^n =0.5/〖1.1〗^n
Next, relate the prices before and after dividend to taxes using the following formula:
P_B=Price before dividend=10
P_A=Price after dividend=9.2
t_o=Tax on ordinary income=50%
t_cg=Tax on capital gains=0.5/〖1.1〗^n
Substituting the values into the formula:
Simplifying the expressions to solve for n gives:
Solving for n using logarithms gives:
The capital gains taxes are being deferred by 3 years.
|Question 4||Ordinary income tax rate||40%|
|Effective Tax Rate on Dividends||Price Before Dividend||Dividend||Price After Dividend||Change in Share Price||Capital gains tax rate||28%|
|6.00%||10||0.5||9.35||0.65||% of exempt dividend||85%|
First, we evaluate the effective tax rate on dividends.
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒 𝑜𝑛 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠=(𝑇𝑎𝑥 𝑟𝑎𝑡𝑒 𝑜𝑛 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑖𝑛𝑐𝑜𝑚𝑒)(1−% 𝑜𝑓 𝑒𝑥𝑒𝑚𝑝 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠)
𝑂𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑖𝑛𝑐𝑜𝑚𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒=40%
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛𝑠 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒=28%
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒=$0.50
% 𝑜𝑓 𝑒𝑥𝑒𝑚𝑝𝑡 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠=85%
Substituting the values into the equation.
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒 𝑜𝑛 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠=(0.4)(1−0.85)
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒 𝑜𝑛 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠=0.06=6%
Next, use the equation relating the prices before and after dividends to taxes to find the change in share price.
𝑃_𝐵=𝑃𝑟𝑖𝑐𝑒 𝑏𝑒𝑓𝑜𝑟𝑒 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑=$10
𝑃_𝐴=𝑃𝑟𝑖𝑐𝑒 𝑎𝑓𝑡𝑒𝑟 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑
𝑡_𝑜=𝑇𝑎𝑥 𝑜𝑛 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑖𝑛𝑐𝑜𝑚𝑒=6%(𝐴𝑓𝑡𝑒𝑟 𝑎𝑑𝑗𝑢𝑠𝑡𝑚𝑒𝑛𝑡)
𝑡_𝑐𝑔=𝑇𝑎𝑥 𝑜𝑛 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑔𝑎𝑖𝑛𝑠=28%
Substituting the given and calculated values into the equation.
Making 𝑃_𝐴 the subject of the equation.
The share price drops from $10 to $9.35 after the dividend.
Damodaran, A. (2010). Applied corporate finance. John Wiley & Sons.
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Week 8 Chapter 10 Questions
Select three formula-driven-problems from Chapter 10 that you wish to showcase and prepare a Microsoft Excel document showing the Excel formulas used to prepare the solution for those problems.
REMINDER: Part of the grade that you receive on your problems is the utilization of Formulas. Therefore, do not pick problems that only require a narrative!
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