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Hybrid Financing and Bonds

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 1.0%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

A. 6.66%
B. 6.99%
C. 7.34%
D. 7.71%
E. 8.09%

Solution Summary

This solution calculates the coupon rate on preferred stock by using the required after tax return on preferred stock and after tax return on bond. All steps are shown in a clear and structured manner.