Mariano Manufacturing can issue a 25-year, 8.1% annual payment bond at par Its investment bankers also also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%, which would represent an after-tax risk premium What coupon rate must be set on the preferred in order to issue it at par?
A) 6.66%
B) 6.99%
C) 7.34%
D) 7.71%
E) 8.09%

Question

Quizplus · Accepted Answer

The correct answer is A.The after-tax return on the bonds is 8.1% * (1 - 40%) = 4.86%. The after-tax return on the preferred must be 4.86% + 1.0% = 5.86%. The coupon rate on the preferred must be 5.86% / (1 - 40%) = 6.66%.

Mariano Manufacturing Can Issue a 25-Year, 8