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Suppose you buy 300 shares of stock priced at $78
Suppose you buy 300 shares of stock priced at $78.90 and sell the stock one year later for $83.20 after collecting a $0.60 dividend per share. Dividend income is taxed at a 28% rate and capital gains are taxed at 20%. What was your pre-tax holding period return? What was your after-tax holding period return? (5 Marks)
Expert Solution
Initial price = P0 = $78.9
Final price = P1 = $83.2
Dividend = D0 = $0.6
Tax on dividend income = 28%
Tax on Capital gains = 20%
Pre-tax capital gain = P1 - P0 = 83.2 - 78.9 = $4.3
Pre-tax dividend = $0.6
Pre-tax holding period return = [Pre-tax capital gain + Pre-tax dividend] / Initial price
Pre-tax holding period return = [4.3 + 0.6] / 78.9
Pre-tax holding period return = 4.9 / 78.9
Pre-tax holding period return = 0.0621 = 6.21%
Tax on dividend income = 28%
Tax on dividend income = 28% of 0.6 = 28% * 0.6
Tax on dividend income = $0.168
After tax dividend = Dividend - Tax on dividend income
After tax dividend = 0.6 - 0.168
After tax dividend = $0.432
Tax on Capital gains = 20%
Capital gains = P1 - P0 = 83.2 - 78.9
Capital gains = 4.3
Tax on capital gains = 20% of Capital gain = 20% * 4.3
Tax on capital gains = 0.86
After tax capital gain = Capital gains - Tax on capital gains
After tax capital gain = 4.3 - 0.86
After tax capital gain = $3.44
After-tax holding period return = [After tax dividend + After tax capital gain] / Initial price
After-tax holding period return = [0.432 + 3.44] / 78.9
After-tax holding period return = 3.872 / 78.9
After-tax holding period return = 0.0491 = 4.91%
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