Question: This question is based on a model proposed by N. Elton and M. Gruber (1970), Marginal Stockholder Tax Rates and the Clientele Effect, published in

This question is based on a model proposed by N. Elton and M. Gruber (1970), Marginal Stockholder Tax Rates and the Clientele Effect, published in Review of Economics and Statistics. The model incorporates tax effects into determining the ex-dividend price, and can be written as:

(P0 PX)/D = (1 TP)/(1 TG),

where P0 is the price just before the stock goes ex, PX is the ex-dividend share price, D is the amount of the dividend per share, TP is the relevant marginal personal tax rate on dividends, and TG is the effective marginal tax rate on capital gains.

a. If TP = TG = 0, how much will the share price fall when the stock goes ex?

b. If TP = 15 percent and TG = 0, how much will the share price fall?

c. If TP = 15 percent and TG = 30 percent, how much will the share price fall?

d. Suppose the only owners of stock are corporations. Recall that corporations get at least a 100 percent exemption from taxation on the dividend income they receive, but they do not get such an exemption on capital gains. If the corporation's income and capital gains tax rates are both 35 percent, what does this model predict the ex-dividend share price will be?

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