Principles of Corporate Finance
Principles of Corporate Finance
13th Edition
ISBN: 9781260465099
Author: BREALEY, Richard
Publisher: MCGRAW-HILL HIGHER EDUCATION
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Chapter 16, Problem 30PS

a)

Summary Introduction

To identify: The marginal investors that determine the prices of the stocks.

a)

Expert Solution
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Explanation of Solution

The marginal investors who determine the prices of the stocks are institutions.

b)

Summary Introduction

To determine: The prices of the low-, medium-, and high-payout stocks.

b)

Expert Solution
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Explanation of Solution

Computation of price of the low-, medium-, and high-payout stocks is as follows:

Price of low-payout stock, p0=DAfter-tax return rate=$200.12=$166.67

Price of medium-payout stock, p0=DAfter-tax return rate=$100.12=$83.33

Price of high-payout stock, p0=DAfter-tax return rate=$300.12=$250

Therefore, the price of low-, medium-, and high-payout stock is $166.67, $83.333, and $250 respectively.

c)

Summary Introduction

To determine: The after-tax returns of the three types of stock for each investor group.

c)

Expert Solution
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Explanation of Solution

The institution after-tax rate of return is 12% for each type of stock and the individual’s after-tax returns are as follows:

For low-payout stock, r=[(0.50×D)+(0.85×capital gains)]P0=[(0.50×$5)+(0.85×$15)]$166.67=$15.25$166.67=0.0915or 9.15% 

For medium-payout stock, r=[(0.50×D)+(0.85×capital gains)]P0=[(0.50×$5)+(0.85×$5)]$83.33=$6.75$83.33=0.0810or 8.10%

For high-payout stock, r=[(0.50×D)+(0.85×capital gains)]P0=[(0.50×$30)+(0.85×$0)]$250=$15$250=0.06or 6%

Therefore, the individuals after-tax rate of return of low-, medium-, and high-payout stock is 9.15%, 8.10%, and 6% respectively.

For corporations, after-tax rate of return is as follows:

For low-payout stock, r=[(0.95×D)+(0.65×capital gains)]P0=[(0.95×$5)+(0.65×$15)]$166.67=$14.5$166.67=0.087or 8.7%

For medium-payout stock, r=[(0.95×D)+(0.65×capital gains)]P0=[(0.95×$5)+(0.65×$5)]$83.33=$8$83.33=0.096or 9.6%

For high-payout stock, r=[(0.95×D)+(0.65×capital gains)]P0=[(0.95×$30)+(0.65×$0)]$250=$28.5$250=0.114or 11.4%

Therefore, the corporations after-tax rate of return of low-, medium-, and high-payout stock is 8.70%, 9.60%, and 11.40% respectively.

d)

Summary Introduction

To determine: The dollar amounts of the three types of stock held by each investor group.

d)

Expert Solution
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Explanation of Solution

Following table shows the dollar amounts of the three types of stock held by each investor group:

 Low payoutMedium payoutHigh payout
Individuals$80 billion  
Corporations  $10 billion
Institutions$20 billion$50 billion$110 billion

Table no.1

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