Why is the cost of debt normally lower than the cost of preferred stock?
A) Preferred stock dividends are tax deductions.
B) Interest on debt is tax deductible.
C) Preferred stock dividends must be paid before common stock dividends.
D) Common stock dividends are not tax-deductible.

Question

Quizplus · Accepted Answer

The cost of debt is lower than the cost of preferred stock because interest on debt is tax deductible, which reduces the net cost of borrowing. Unlike preferred stock dividends, which are not tax deductible, interest on debt is tax deductible. Therefore, the after-tax cost of debt is lower than the after-tax cost of preferred stock.

Why Is the Cost of Debt Normally Lower Than the Cost