Question

Assume that Shavonne's marginal tax rate is 37 percent and her tax rate on dividends is 20 percent. If a corporate bond pays 8.8 percent interest, what dividend yield would a dividend-paying stock (with no growth potential) have to offer for Shavonne to be indifferent between the two investments from a cash-flow perspective?

Answer 1

Answer:

Interests received from corporate bonds is taxed as ordinary income = 8.8% x (1 - 37%) = 5.544% after tax yield

Non-qualified dividends are also taxed as ordinary income, therefore, the after tax yield of a non-qualified dividend that yields 8.8% = 5.544%

Qualified dividend pay a lower tax rate, since they are taxed as long term capital gains. If the after tax yield will be the same, then:

5.544% = dividend yield x (1 - 20%)

5.544% / 0.8 = dividend yield

6.93% = dividend yield