Question

A corporation in a 34% tax bracket invests in the preferred stock of another company and earns a 6% pretax rate of return. An individual investor in a 15% tax bracket invests in the same preferred stock and earns the same pretax return. The after-tax return to the corporation is ________, and the after-tax return to the individual investor is ________.

Answer 1

Answer:

The after-tax return to the corporation is 3.96%, and the after-tax return to the individual investor is 5.1%.

Explanation:

The after tax return of the corporation = 6% x (1 - tax rate) = 6% x (1 - 34%) = 6% x 66% = 3.96%

The after tax return of an individual investor = 6% x (1 - tax rate) = 6% x (1 - 15%) = 6% x 85% = 5.1%

When corporations earn dividends from common stock, they usually have to pay lower taxes due to dividends received deduction (DRD) which range from 70% - 100%, but they do not apply to dividends received from preferred stocks.

Answer 2

Answer:

5.38% and 5.1%

Explanation:

In this question, we are asked to calculate the after tax return to the corporation and the after tax return to the investor.

What is meant by after tax return is simply the profit made after we subtract the amount of taxes. It is simply revenue less the amount of tax paid.

We calculate the values as follows:

For the corporation;

The after tax return can be calculated by the following mathematical expression;

After tax return to Corporation = 0.06 - (0.06 * 0.3) * 0.34 = 0.0538 = 5.38/100 which is same as 5.38%.

After tax return to the individual investor = 0.06(1-0.15) = 0.06 * 0.85 = 0.051 or just 5.1%