Suppose that the pre-tax holding period returns on two stocks are the same. Stock A has a high dividend-payout policy and stock B has a low dividend-payout policy. If you are an individual in a high marginal tax bracket and do not intend to sell the stocks during the holding period,
A) stock A will have a higher after-tax holding period return than stock B.
B) the after-tax holding period returns on stocks A and B will be the same.
C) stock B will have a higher after-tax holding period return than stock A.
D) it is impossible to determine which stock will have a higher after-tax holding period return given the information available.

Question

Quizplus · Accepted Answer

Stock B will have a higher after-tax holding period return than stock A because dividends are typically taxed at the individual's marginal tax rate. Since stock A has a high dividend-payout policy, more of its return will be subject to taxation, reducing the after-tax return for an individual in a high marginal tax bracket compared to stock B, which has a low dividend-payout policy and thus less of its return is subject to immediate taxation.

Suppose That the Pre-Tax Holding Period Returns on Two Stocks