Which of the following statements is correct about a corporation in the 35% tax bracket that can invest either in a bond paying 8% interest or in the preferred stock of another corporation that pays a 6% dividend?
A) The stock is preferred by approximately .17%.
B) The stock is preferred by approximately .80%.
C) The bond is preferred by approximately 1.30%.
D) The after-tax yields are identical on each.

Question

Quizplus · Accepted Answer

Corporations can exclude 50% of dividends received from taxable income, so the effective tax rate on dividends is lower. The after-tax yield on the bond is 5.2% (8% * (1 - 0.35)), while the after-tax yield on the stock is approximately 5.37% (6% * (1 - 0.35 * 0.5)). Thus, the stock is preferred by approximately 0.17%.

Which of the Following Statements Is Correct About a Corporation