Look again at Table 17.2. What would happen to the price and pretax rate of return on stock B if the tax on capital gains were eliminated?

TABLE 17.2 Effects of a shift in dividend policy when dividends are taxed more heavily than capital gains. The high-payout stock (firm B) must sell at a lower price in order to provide the same after-tax return Firm A $112.50 $0 $112.50 $100 $12.50 12.5 100=.125-12.5% $0 20 $12.50 = $2.50 Firm B $102.50 $10.00 $112.50 $97.78 $4.72 14.72 97.78 40 $ 10 = $4.00 20 x $4.72- $.94 Next year's price Dividend Total pretax payoff Today's stock price Capital gain Before-tax rate of return (%) , 1 505-15.05% Tax on dividend at 40% Tax on capital gain at 20% Total after-tax income (dividends plus capital gains less taxes) (0 +12.50)-2.50 $10.00 (10 4.72)- (4.00 .94) $9.78 9.78 97.78 After-tax rate of return (%) 10 10% .10-10% 100