Ask Colin

If a share is sold for $39.00, less than 90 days after purchase, will the return to an investor be greater if he bought cum an 80c dividend at $35.00 or on the ex dividend date for $34.20?

Since the shares are sold in under a year, full tax is paid on the capital gain and the dividend.

Since the ex-dividend price is exactly 80c less than the cum dividend price, the dividend is presumably unfranked, since otherwise the price would theoretically fall by more than the cash dividend to take account of the value of the imputed credit attached to the dividend. It also means we do not have to worry about the 45-day rule if the holding period (less than 90 days) was also less than 45 days (practically about 48 days).

These two things mean we can compare them pre-tax.

In the case of the cum dividend purchase, the before tax profit is $39 - 35 + .80 = $4.80.

In the case of the ex dividend purchase, the before tax profit is $39 - 34.2 = $4.80.

There are some unknowns in your question that affect the answer from that point onward:

1. How soon before the ex date was the cum dividend purchase made. Its holding period is longer. We need to know by how much to annualise the return.

2. When is the dividend actually received? We need to take into account the return from investing the dividend for the remainder of the period of the investment. We also need to assume an interest rate.

Ignoring these things, since the profit is the same, the return is higher for the ex-dividend purchase because less capital was required ($34.20 vs. $35.00). However, the annualised return will be greater depending on how much longer the cum dividend purchase was held and lower depending on the value of the reinvestment of the dividend.

From this, I think you should be able to complete the exercise yourself.

I would comment though that this is a highly academic exercise unless very large sums of money are involved, because i feel that the difference between the two scenarios will be marginal.

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