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General Manufacturing Company (GMC) follows a policy of paying out 50 percent of its net income as cash dividends to its shareholders each year. The company plans to do so again this year, during which GMC earned $100 million in net profits after tax. The company has 40 million shares outstanding and pays dividends annually.
Assume that an investor purchased GMC stock a year ago at $45. The investor, who faces a personal tax rate of 15 percent on both dividend income and on capital gains, plans to sell the stock very soon. Transactions costs are negligible.
a. Calculate the after-tax return this investor will earn if she sells GMC stock at the current $54 stock price prior to the ex-dividend date.
b. Calculate the after-tax return the investor will earn if she sells GMC stock on the ex-dividend date, assuming that the price of GMC stock falls by the dividend amount on the ex-dividend date.
c. Calculate the after-tax return the investor will earn if she sells GMC stock on the ex-dividend date, assuming that the price of GMC stock falls by one half the dividend amount on the ex-dividend date.
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