Solarcell Corporation has $20,000 that it plans to invest in marketable securities.It is choosing between AT&T bonds that yield 11%,State of Florida municipal bonds that yield 8%,and AT&T preferred stock with a dividend yield of 9%.Solarcell's corporate tax rate is 29.00%,and 70% of the preferred stock dividends it receives are tax exempt.Assuming that the investments are equally risky and that Solarcell chooses strictly on the basis of after-tax returns,which security should be selected? Answer by giving the after-tax rate of return on the highest yielding security.

Question

Quizplus · Accepted Answer

The after-tax rate of return on the AT&T bonds is 11% - (11% x 29%) = 7.81%. The after-tax rate of return on the State of Florida municipal bonds is 8%. The after-tax rate of return on the AT&T preferred stock is 9% - (9% x 29%) + (9% x 29% x 70%) = 8.46%. Therefore, the AT&T preferred stock is the highest yielding security with an after-tax rate of return of 8.46%.

Solarcell Corporation Has $20,000 That It Plans to Invest in Marketable