Question

1(a). (TRUE or FALSE?) There is a tax adjustment downward in the cost of preferred stock calculation because dividend payments on preferred stocks can be deducted by the firms on their taxable income.

1(b). (TRUE or FALSE?) When a company issues new securities flotation costs increase the cost of raising the capital.

1(c). (TRUE or FALSE?) Since interest payments are not tax deductible, the true cost of the debt is the before tax cost.

1(d). (TRUE or FALSE?) We need to earn at least the half of the required return to compensate our investors for the financing they have provided.

Answer 1

1(a). There is a tax adjustment downward in the cost of preferred stock calculation because dividend payments on preferred stocks can be deducted by the firms on their taxable income.

False, Dividend payments on preferred stock is not tax deductible like common equity stock. So no cost is reduced.

1(b). When a company issues new securities flotation costs increase the cost of raising the capital.

True, Floatation cost reduces the cash received on security issued, which indirectly increases the cost of security.

1(c). Since interest payments are not tax deductible, the true cost of the debt is the before tax cost.

False, Interest cost is tax deductible, hence true cost is after tax cost.

1(d). We need to earn at least the half of the required return to compensate our investors for the financing they have provided.

False, Investors required rate of return so their value of money can be increased, so required rate must be achieved, and if possible maximum rate should be earned.