Answered

Find accurate and reliable answers to your questions on IDNLearn.com. Our platform offers detailed and accurate responses from experts, helping you navigate any topic with confidence.

The Gecko Company and the Gordon Company are two firms that have the same business risk but different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 2.9 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 35 percent. Gecko has an expected earnings growth rate of 12 percent annually, and its stock price is expected to grow at this same rate.

Required:
If the aftertax expected returns on the two stocks are equal (because they are in the same risk class), what is the pretax required return on Gordon’s stock?

Sagot :

TutorAnneidn

Answer:

Gordon's  Pretax return  is 13.015%

Explanation:

Dividend yield of Gordon  =2.9% =0.029

Tax rate = 35% =0.35

Gordon's after-tax return = Gecko's after-tax return =12 % (This is because  the capital gains tax is zero)

Using the formulae

After-tax return  of Gordon= Capital gains yield + Dividend yield x  (1-tax rate)

0.12 =  Capital gains yield + (0.029  x ( 1 - 0.35)

0.12 = Capital gains yield + (0.029 X 0.65)

0.12 = Capital gains yield + 0.01885

Capital gains yield= 0.12 -0.01885 =0.101155

  Pretax return  is given as

Capital gains yield + Dividend yield

= 0.101155+ 0.029 =0.13015 x 100=13.015%

Therefore, Gordon's  Pretax return  is 13.015%

 

We appreciate your presence here. Keep sharing knowledge and helping others find the answers they need. This community is the perfect place to learn together. Your search for answers ends at IDNLearn.com. Thank you for visiting, and we hope to assist you again soon.