Question

Compare the after-tax rates of return for a Canadian corporate investor from the following two investments: A 20-year, Canadian corporate bond that sells for par and offers a 9 percent coupon versus an investment in preferred stock that sells for $40.00 per share and pays a $2.40 dividend. The corporation has a 35 percent tax rate.

Answer 1

Solution:
	The after-tax rates of return for a Canadian corporate investor
	Corporate bond	5.85%
	Preferred stock	3.90%
	Return after tax is higher on corporate bond for the Canadian corporate investor
Working Notes:
	Corporate bond	5.85%
	Since, bond is being sold at Par its YTM will be equal to Coupon rate = 9%
	Return after tax = Coupon rate x ( 1- tax rate)
	= 9% x (1 - 0.35)
	=9% x 0.65
	=5.85 %
	Corporate bond return after tax	5.85%
	Preferred stock
	Preferred stock yield = Preferred dividend / price
		=$2.40/$40
		=0.06
		=6%
	Return after tax = Preferred stock yield x ( 1- tax rate)
	= 6% x (1 - 0.35)
	=6% x 0.65
	=3.9 %
	Preferred stock return after tax	3.90%
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