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 that the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis is true. The cost of preferred stock is the same for a company on a before-tax and after-tax basis because the dividends paid on preferred stock are not tax deductible. This contrasts with bonds, where interest payments are tax deductible and reduce the after-tax cost of debt.

Step-by-step explanation:

Unlike bond interest, which is tax deductible, the dividends paid on preferred stock are not. Therefore, the tax treatment does not alter the cost of preferred stock financing for the company, making the cost consistent regardless of the tax consideration.

When a firm decides how to access financial capital and issues preferred stock, it does not have tax deductibility advantages that come with debt financing through bonds. The cost of issuing preferred stock remains the same because no tax benefits apply to reduce the effective cost as they do with bond interest payments.