I know the equation, and I’m trying to understand the concept behind it (so as to help me remember the relationships in the equation).
Basically there’s a larger share price drop when marginal tax rates on dividends are LOWER than marginal tax rates on capital gains (to investors). There’s a lower price drop when taxes on Dividends are relatively HIGH.
I don’t understand the reasoning behind this, and couldn’t grasp it from the CFAI text. can anyone help?? To me, if dividend tax rates are LOW, demand for stock on ex-div date would be high, so i don’t understand the price drop would be larger when dividend taxes are low…
That’s the equation. Higher taxes on either would lessen the amount of real dollars that you get.
If taxes on dividends were 100%, meaning that the government confiscates all distributions to shareholders, then the stock price (capital gain) would not be affected by the timing or the amount of dividends.
The more dividends you get, the bigger piece you bite out of the stock price, since the stock price has all cash flows priced in. Remove $2.5 from the share, and you’re share price lessens by that amount (assuming no tax) on the day of payment.