A corporation can invest $ 10,000 in preferred stock that pays a 6% dividend and does not appreciate in price. The corporation faces a 40% tax rate. Dividends from the stock are eligible for the 70% corporate dividends received deduction. That is, the corporation has to include only 30% of the dividend in its taxable income. This results in an effective tax rate on the dividend of 12% (= .30 × .40). Assume dividend income is reinvested in more 6% preferred stock.
a. Find the after tax accumulation for this investment after 10 years.
b. Find the annualized after tax rate of return on this investment after 10 years. (Exercise adapted from problem written by Richard Sansing, Dartmouth College.)