Question

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.

Answer 1

Answer:

9.10%

Explanation:

Data provided in the question:

Buying cost of the preferred stocks = $40

Selling cost of the preferred stock = $40

Dividends received = $4

Now,

The total before-tax income = Dividend received =  $4

After the 70% exclusion for preferred stock dividends,

The taxable income = 0.30 × $4

= $1.20

Thus,

Taxes = 0.30 × $1.20

= $0.36

Therefore,

The After-tax income

= $4.00 - $0.36

= $3.64

Hence,

Rate of return = [ After-tax income ÷ Buying cost ] × 100%

= [ $3.64 ÷ $40.00 ] × 100%

= 9.10%