Use the following information to answer the question(s)below.
Suppose that all capital gains are taxed at a 20% rate,and that the dividend tax rate is 40%.Rearden Metal is currently trading for $40 per share,and is about to pay a $5 special dividend.
-The effective dividend tax rate for an investor in Rearden Metal is closest to:
A)0%.
B)20%.
C)25%.
D)30%.

Question

Quizplus · Accepted Answer

The effective dividend tax rate takes into account the impact of the dividend and the change in the stock price. In this case, the $5 special dividend will be taxed at a 40% rate, so the investor will receive $3 (60% of $5) after taxes. The stock price will adjust downward by $5, so the investor will have a capital loss of $5 that can offset capital gains in the future. If the investor were to sell the stock immediately after the dividend payment, they would have a capital loss of $5 and a dividend of $3, for a total loss of $2. However, since all capital gains are taxed at a 20% rate, the investor will be able to offset $1 of future capital gains with the loss. Therefore, the effective tax rate on the dividend is 40% - 20% + (20% x 40%) = 28%, which is closest to choice C).

Use the Following Information to Answer the Question(s)below