Mariano Manufacturing can issue a 25-year, 8.8% annual payment bond at par.Its investment bankers also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 25% 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?

Question

Quizplus · Accepted Answer

The correct answer is A.The after-tax return on the bonds is 8.8% * (1 - 25%) = 6.6%. The after-tax return on the preferred must be 6.6% + 1.0% = 7.6%. The coupon rate on the preferred must be 7.6% / (1 - 25%) = 8.27%.

Mariano Manufacturing Can Issue a 25-Year, 8