CFA Exam 2005 Question 8

Yeo is taxed 28% on investment income, but not on capital gain. To my understanding, this means that the dividend income will be taxed but not the annual return. So it seems to me that “Domestic Equity: Income” still generate higher after tax return. Can somebody help me understand what’s the math and why “Domestic Equity: Growth” is the preferred choice for Yeo? E(Annual Return) E(S.D) E(Dividend Yield) Domestic equity: Income 13.5% 13.7% 7.5% Domestic equity: Growth 12.5% 13.9% 0%

Domestic Income ISNT the preferred choice b/c for 1) it has a lower AT return & 2) Yeo isnt taxed on Capital Gains so you want Growth over Income.

But for Domestic equity: Income investment, the expected annual return portion will be capital gain? The dividend yield portion will be investment income gain? so Yeo can get 13.5% + 7.5% * (1-0.28) return On Domestic equity: Growth investment Yeo can only get only 12.5% return? If my understanding is correct, “Domestic equity: Income” is better than “Domestic equity: Growth”?

NO. The 13.5% includes the 7.5% income so the actual return is only 11.4% after-taxes.