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After-tax return on the preferred stock

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Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 2.25%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

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Note - 70% of preferred dividend is tax exempted, so preferred investor will pay taxes on 30% of coupon rate. That is there ...

Solution Summary

The solution computes the after-tax return on the preferred required by coporate investors that exceeds their after-tax return on the bonds.