Solarcell Corporation has $20,000 that it plans to invest in marketable securities.It is choosing between AT&T bonds that yield 11.00%,State of Florida municipal bonds that yield 8.00%,and AT&T preferred stock with a dividend yield of 9.00%.Solarcell's corporate tax rate is 39.00%,and 70.00% of the preferred stock dividends it receives are tax exempt.Assuming that the investments are equally risky and that Solarcell chooses strictly on the basis of after-tax returns,which security should be selected? Answer by giving the after-tax rate of return on the highest yielding security.

Question

Quizplus · Accepted Answer

11ea856c_8c02_8982_9aec_517d91f1dbf5_TB1222_00 Since municipal bonds are exempt from federal taxes,its BT return = AT return
AT municipal bond yield 8.00%
AT bond yield = BT bond yield 11ea856c_8c02_8983_9aec_bf5b32b3bd61_TB1222_11 (1 - T)
AT bond yield = 6.71%
AT preferred yield = BT pref.return [1 - (1 - Div exclusion%)(T)]
AT preferred yield = 7.95%
Highest AT yield = 8.00%

Solarcell Corporation Has $20,000 That It Plans to Invest in Marketable