Q-Bank - after tax return

Samuel Davidson, CFA, is an investment advisor for The Karazim Group (Karazim), a financial planning and investment firm catering to wealthy individuals in the United States. Davidson has called a client, Kelly Musch, to discuss increasing the international exposure in her portfolio. Since Musch is unfamiliar with foreign investments and their risk evaluation, she has expressed an interest in meeting with Davidson to discuss the matter. During the course of their discussion, she indicated an interest in firms located in Greece, explaining to Davidson that her grandparents are originally from Greece and she is knowledgeable about the culture there. Consequently, she is more comfortable investing in Greece as opposed to other countries. In preparation for the meeting Davidson gathered current data on Greece (Figure 1) to illustrate some issues relevant to international investments. Figure 1: Current Data on Greece and the United States Current Exchange Rate 1 EUR = USD0.80 Expected Exchange Rate in Three Months 1 EUR = USD0.85 Greece ST Capital Gains/Dividend Tax Rate 15.00% U.S. ST Capital Gains/Dividend Tax Rate 28.00% Because she is in a high tax bracket, Musch is concerned about the tax ramifications of international investments. To illustrate how taxes work on Greece investments, Davidson prepares an example that assumes that Musch buys 100 shares of KDR Corporation. KDR is currently trading in Greece at EUR28 per share. In his example, Davidson makes the simplifying assumption that there are no transaction costs. The illustration assumes that Musch holds the shares for three months and receives a dividend of EUR1.0. After three months, Musch sells the shares at a price of EUR30 per share. In Davidson’s investment example concerning KDR Corporation, the difference between the pre-tax return and the after tax return is: A. 8.71% B. 13.02% C. 4.93% D. 1.43%

C since US tax is higher for both dividends and capital gains - total tax is based on US (investor has to pay Greek taxes, gets a tax credit, pays taxes in the US using the tax credit) initial investment: 28*100*0.8 terminal value: (1+30)*100*0.85 Gross Return (31*.85-28*.8)/28*.8 Net Return = Gross Return - 0.28*(31*.85-28*.8)/28*.8 -> Net Return - Gross return = 0.28*(31*.85-28*.8)/28*.8 = 4.94% -> C

C Original cost $2240 Pretax return: $395 After-Tax Return: $284.40

Does this mean I’m going to have to learn US Tax law? How pointless.

Your answer: C was correct! EUR dividend per share = EUR1.0 × (1 − 0.15) = EUR0.85 Net USD dividend on 100 shares = EUR0.85 × 100 × 0.85USD / EUR = USD72.25 Tax credit in USD on 100 shares = EUR0.15 × 100 × 0.85USD / EUR = USD12.75 USD proceeds from sale of 100 shares = EUR30 × 100 × 0.85USD / EUR = USD2,550.00 Cost of 100 share in USD = EUR2,800 × 0.80USD / EUR = USD2,240.00 ST capital gains tax = (USD2,550 − USD2,240) × 0.28 = USD86.80 Tax on gross dividend = USD85 × 0.28 = USD23.80 Total pre-tax return = (2,550 − 2,240 + 85.00) / 2,240 = 0.1763 Total after-tax return = [(2,550 − 2,240 + 72.25) − 86.80 − 23.80 + 12.75] / 2,240 = 0.1270 Impact of taxes on total return = 0.1763 − 0.1270 = 0.0493 as per usual, maratikus ironed out a much easier way to intuitively answer this. you should draw up your own set of study notes, dude. I’d pay for them.

I prefer wanderingcfa’s way. Looking at it that way made it so much simpler.