Dividends and Taxes In the absence of market imperfections and tax effects, we would expect the share price to decline by the amount of the dividend payment when the equity goes ex dividend. Once we consider the role of taxes, however, this is not necessarily true. One model has been proposed that incorporates tax effects into determining the ex-dividend price (Elton and Gruber, 1970):

6 where P0 is the price just before the share goes ex, PX is the ex-dividend share price, D is the amount of the dividend per share, tP is the relevant marginal personal tax rate on dividends, and tG is the effective marginal tax rate on capital gains.

(a) If tP = tG = 0, how much will the share price fall when the equity goes ex?

(b) If tP = 36.1 per cent and tG = 0, how much will the share price fall?

(c) If tP = 36.1 per cent and tG = 28 per cent, how much will the share price fall?

(d) What does this problem tell you about real-world tax considerations and the dividend policy of the firm?