How much should an investor pay now for a stock expected to sell for $30 one year from now if: the stock offers a $2 dividend, dividends are taxed at 40%, capital gains are taxed at 20%, and a 15% after-tax return is expected on the investment?

Question

Quizplus · Accepted Answer

First, we need to calculate the after-tax dividend: $2 x (1 - 0.4) = $1.20. 
Next, we need to calculate the before-tax capital gain required to achieve a 15% after-tax return: 15% / (1-0.2) = 18.75%. 
Finally, we can use the dividend discount model to calculate the present value of the stock: 
PV = ($1.20 + $30) / (1 + 0.1875) = $26.53. Therefore, an investor should pay $26.53 for the stock now.

How Much Should an Investor Pay Now for a Stock