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Homework answers / question archive / 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

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

Finance

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. 

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Computation of the after tax rate of return:-

The bond is selling at par so the yield to maturity (YTM) is equal to coupon rate.

After tax rate of return = YTM * (1 - Tax rate)

= 9% * (1 - 35%)

= 5.85%

 

?Preferred stock return = Annual dividend / Preference share price

= $2.40 / $40

= 6%

After tax rate of return = Preferred stock return * (1 - Tax rate)

= 6% * (1 - 35%)

= 3.90%

 

After tax rate of return on corporate bond = 5.85%

After tax rate of return on preferred stock = 3.90%

Canadian corporate bond has higher after-tax rate of return of 5.85% compared to Preferred stock's after-tax rate of return of 3.90%.

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