Mantle Corporation is considering two equally risky investments:
∙A $5,000 investment in preferred stock that yields 7%.
∙A $5,000 investment in a corporate bond that yields 10%.
What is the break-even corporate tax rate that makes the company indifferent between the two investments?
A)34.27%
B)36.08%
C)37.97%
D)39.87%
E)41.87%

Question

Quizplus · Accepted Answer

The break-even corporate tax rate is calculated by equating the after-tax yields of the two investments. The preferred stock yield is 7%, and the bond yield is 10%. The after-tax yield on the bond is 10% * (1 - tax rate). Setting the after-tax yields equal gives 7% = 10% * (1 - tax rate). Solving for the tax rate gives a break-even rate of 37.97%.

Mantle Corporation Is Considering Two Equally Risky Investments