Question

The Shrieves Corporation has $25,000 that it plans to invest in marketable securities. It is choosing among AT&T bonds, which yield 9.75%, state of Florida muni bonds, which yield 5% (but are not taxable), and AT&T preferred stock, with a dividend yield of 8.25%. Shrieves' corporate tax rate is 40%, and 70% of the dividends received are tax exempt. Find the after-tax rates of return on all three securities. Round your answers to two decimal places.

Answer 1

the after tax rate of return = yield x ( 1 - tax rate)

• AT&T bonds after tax rate of return = 9.75% x ( 1 - 40%) = 9.75% x 60% = 5.85%
• State of Florida municipal bonds after tax rate of return = 5% (no tax rate)
• AT&T preferred stock after tax rate of return = 8.25% x [1 - (40% x 30%)] = 8.25% x (1 - 12%) = 8.25% x 88% = 7.26%