Question

A corporation buys $100 par value preferred stock of another corporation. The dividend payment is 7.8 percent of par. The corporation is in a 35 percent tax bracket.
a. What will be the after-tax return on the dividend payment? Fill in the following table.
Par value 
Dividend payment (%) 
Actual dividend 
Taxable income (30% of dividend) 
Taxes (35% of taxable income) 
After-tax return (Actual dividend – Taxes) 
Percent return = 
After-tax return 
Par value 
b. Assume a second investment in a $1,000 par value corporate bond pays 8.6 percent interest. What will be the after-tax return on the interest payment? Fill in the table below.
Par value 
Interest payment (percent) 
Actual interest 
Taxes (35 percent of interest) 
After-tax return (Actual interest – Taxes) 
Percent return = 
After-tax return 
Par value 
c. Should the corporation choose the corporate bond over the preferred stock because it has a higher quoted yield (8.6 percent versus 7.8 percent)?


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  • CreatedSeptember 21, 2015
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