If the short-term commercial paper rate is 10 percent and the corporate tax rate is 35 percent, what yield would a corporation require on an investment in auction-rate preferred stock? Assume the default risk is the same as for commercial paper.

Question

Quizplus · Accepted Answer

The after-tax yield on commercial paper is 10% * (1 - 0.35) = 6.5%. To be equivalent, the yield on auction-rate preferred stock should be 6.5% / (1 - 0.35) = 10% before tax, which is approximately 7.3% after tax.

If the Short-Term Commercial Paper Rate Is 10 Percent and the Corporate