The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 7 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 40 percent. Gecko has an expected earnings growth rate of 16 percent annually, and its stock price is expected to grow at this same rate. If the aftertax expected returns on the two stocks are equal (because they are in the same risk class), what is the pretax required return on Gordon's stock?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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The Gecko Company and the Gordon Company are two firms whose business risk is the same but that
have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield
of 7 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 40 percent. Gecko
has an expected earnings growth rate of 16 percent annually, and its stock price is expected to grow at this
same rate. If the aftertax expected returns on the two stocks are equal (because they are in the same risk
class), what is the pretax required return on Gordon's stock?
Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal
places, e.g., 32.16.
Pretax return
%
Transcribed Image Text:The Gecko Company and the Gordon Company are two firms whose business risk is the same but that have different dividend policies. Gecko pays no dividend, whereas Gordon has an expected dividend yield of 7 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 40 percent. Gecko has an expected earnings growth rate of 16 percent annually, and its stock price is expected to grow at this same rate. If the aftertax expected returns on the two stocks are equal (because they are in the same risk class), what is the pretax required return on Gordon's stock? Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. Pretax return %
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