Question

Stark Industries is thinking of issuing 15-year bonds with a 9.25% annual coupon payment at par. Tony Stark’s bankers have advised him that his company can sell an issue of annual payment preferred stock to the Avengers who are in the 40% tax bracket. The Avengers would require an after-tax return on the preferred stock that will surpass their after-tax return on the bonds by 1.0%; this amount would represent the Avengers after-tax risk premium. At what amount would the coupon rate need to be on the preferred stock in order to issue it at par?

6.55%

6.89%

7.44%

7.79%

8.03%

Answer 1

After tax return on bonds = coupon rate *( 1 - tax rate) = 9.25%*(1-0.40) = 5.55%

now preferred stocks are not tax deductible instruments

So the after tax return on preferred stock = 5.55% + 1% = 6.55 %

Answer : 6.55% (Thumbs up please)