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Question 2-32I

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Essentials Of Investments
Found in: Page 52
Essentials Of Investments

Essentials Of Investments

Book edition 9th
Author(s) Zvi Bodie, Alex Kane, Alan Marcus, Alan J. Marcus
Pages 748 pages
ISBN 9780078034695

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Short Answer

Find the after-tax return to a corporation that buys a share of preferred stock at $40, sells it at year-end at $40, and receives a $4 year-end dividend. The firm is in the 30% tax bracket.

After-tax rate of return = 9.10%

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Step by Step Solution

Definition

Preferred stock is a “non-voting” share of ownership of a fraction in a corporation, proportionate to the number of shares owned. It usually pays a fixed dividend.

Solution

The total before-tax income is $4. After the 70% exclusion, taxable income is:

0.30 x $4 = $1.20

Therefore:

Taxes = 0.30 x $1.20 = $0.36

After-tax income = $4 – $0.36 = $3.64

After-tax rate of return = $3.64 / $40 = 9.10%

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