Question

Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.

A.True
B.False

Answer 1

The statement is true; dividends on preferred stock are not tax deductible, which means the cost of preferred stock to a firm remains constant on both a before-tax and after-tax basis, in contrast to bond interest which is tax deductible.

Step-by-step explanation:

The statement that unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis is true. This is because dividends on preferred stock are not tax deductible for the issuing corporation, whereas interest on bonds is tax deductible. Corporate taxation allows firms to deduct interest expenses when calculating their tax bill, reducing the after-tax cost of debt. However, dividends paid to preferred shareholders do not get such treatment, thereby rendering the cost of preferred stock unchanged when considering taxes.