Since 70 percent of preferred dividends received by a corporation is excluded from taxable income, the component cost of equity for a company which pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be
Cost of equity = rs(0.30)(0.50) + rs(1 − T)(0.70)(0.50).

Question

Quizplus · Accepted Answer

The formula provided is incorrect. The cost of equity is not calculated by adjusting for dividend exclusion or tax rates in this manner. The cost of equity typically involves the expected return required by equity investors, often estimated using models like the Capital Asset Pricing Model (CAPM), and does not directly incorporate dividend payout ratios or tax exclusions.

Since 70 Percent of Preferred Dividends Received by a Corporation