Silver Photo Studios Inc.(SPS)requires $50,000 capital for a proposed expansion.Simon Silver,the company's president and CEO is trying to decide whether to issue preferred shares with a fixed dividend rate of 5%,or to borrow from the bank at a rate of 7%.SPS pays a corporate tax rate of 15%.
Required:

Question

Quizplus · Accepted Answer

The Answer is A)Corporate income of $3,500 ($50,000 × 7%)is required to finance the interest on the bank loan.
Corporate income of $2,941 ($50,000 × 5%)/(1 - .15)is required to finance the dividends on the preferred shares.
B)The cost of the 7% debt is 7%.(3,500/50,000)
The cost of the 5% dividend is 5.9%.(2,941/50,000)