Question

You are considering three stocks with the following expected dividends yields and gains:

Dividend Yield Capital Gain
A. 14% 0%
B. 8 6
C. 0 14
a) Whatis the expected return on each stock?
b) How may transactions costs and capital gains taxes affect your choices?

Answer 1

The expected return on each of the three stocks (A, B, C) is 14%, computed as the sum of their respective dividend yields and capital gains. Transaction costs and capital gains taxes can impact the effective return by reducing the net gains on investments.

Step-by-step explanation:

The expected return on a stock is the sum of its expected dividend yield and capital gain. For the given stocks:

• 
  
• Stock A has an expected return of 14% (all from dividends, as it has no capital gain).
• 
  
• Stock B has an expected return of 14% (8% from dividends and 6% from capital gains).
• 
  
• Stock C has an expected return of 14% (entirely from capital gains, as there is no dividend).

Regarding the impact on choices, transactions costs, such as brokerage fees and commissions, can reduce the effective return on investments, particularly those with expected returns achieved through frequent trades. Capital gains taxes also have an impact, as they are applied to the profit made from selling a stock for more than the purchase price, reducing net returns especially on stocks with high capital gains.