Consider an economy with three types of investor. There are individuals who are taxed at high rates
Question:
Consider an economy with three types of investor. There are individuals who are taxed at high rates on dividend income and low effective rates on capital gains, corporations who pay a high effective tax rate on capital gains and a low rate on dividend income and institutions that pay no taxes on dividends or capital gains.
There are three types of stock in this economy, low payout, medium payout and high payout. The before tax and after tax (i.e. after paying dividends and capital gains taxes at the appropriate rates) total payoffs per share on these three types of stock for the three groups are as follows.
| Stock | Low Payout | Medium Payout | High Payout |
| Before-tax Payoffs | $25 | $25 | $25 |
| After-taxPayoffs for |
|
|
|
| Individuals | $18 | $16 | $12 |
| Corporations | $17 | $19 | $21 |
| Institutions | $25 | $25 | $25 |
The total amount of low, medium and high payout stock in the economy is $750 million,
$900 million and 1,400 million respectively. Individuals' and corporations' total holdings of stock are $600 million and $400 million respectively. All three groups are risk neutral and choose the stocks they invest in to maximize their after-tax income.
a)Give a table showing the equilibrium holdings of individuals, corporations and institutions of low, medium and high payout stocks respectively.
b)If the price of the medium payout stock is $150 per share, what are the prices of the low and high payout stocks, respectively? Explain briefly why they must take on these values
Expert Answer:
Solution a The equilibrium holdings of individuals corporations and institutions of low medium and high payout stocks can be found by solving the foll... View the full answer
