The Munson Company and the Massey Company are two firms whose business risk is t

Question

The Munson Company and the Massey Company are two firms whose business risk is the same but that have different dividend policies. Munson pays no dividend, whereas Massey has an expected dividend yield of 6 percent. Suppose the capital gains tax rate is zero, whereas the income tax rate is 40 percent. Munson has an expected earnings growth rate of 10 percent annually, and its stock price is expected to grow at this same rate.

If the aftertax expected returns on the two stocks are equal (because they are in the same risk class), what is the pretax required return on Massey's

If the aftertax expected returns on the two stocks are equal (because they are in the same risk class), what is the pretax required return on Massey's

Explanation / Answer

Using the constant growth dividend model, we get: After-tax return = g + D(1

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