A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate. The amount of earnings before interest and taxes (EBIT) required to pay the preferred dividends is ________.
A) $1,000,000
B) $400,000
C) $600,000
D) $1,666,667

Question

Quizplus · Accepted Answer

The preferred stock pays a fixed 10% dividend, which means the company needs to earn $1,000,000 in pretax income (EBIT) to pay the preferred stock dividends ($10,000,000 x 10%). However, the company's tax rate is 40%, so the after-tax amount needed to pay the preferred stock dividends is $1,000,000 / (1 - 0.40) = $1,666,667. Therefore, the correct answer is D.

A Corporation Has $10,000,000 of 10 Percent Preferred Stock Outstanding