- CFA Exams
- CFA Level I Exam
- Study Session 7. Corporate Finance (1)
- Reading 21. Analysis of Dividends and Share Repurchases
- Subject 1. Dividend policy and company value: theory

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**CFA Practice Question**

Assume the marginal ordinary income tax for an investor is 40% but for capital gains it is 15%. What would the investor prefer: $100 in dividends or $80 in capital gains?

A. $100 in dividends.

B. $80 in capital gains.

C. The investor would be indifferent.

**Explanation:**After taxes the $100 dividend income is worth 100 (1 - 0.40)/(1 - 0.15) = $70.59. He would certainly prefer $80 in capital gains.

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**User Contributed Comments**
3

User |
Comment |
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rjdelong |
is this the correct application of the formula? it seems the investor would have 80 x .85 = 68 as cap gain and 100 x .6 = 60 as dividend the way the question is phrased. The equation used above is for stocks going ex dividend so the price of the stock would drop by 70.59 if there were a 100 per share dividend... Am I wrong? |

rjdelong |
I see that I am wrong, the formula is used this way. |

rjdelong |
the drop in share price is equiv to a cap gain payout essentially, and $70 cap gain payout is worse than $80 obviously. |