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Scott
Scott, MIT Graduate
Category: General
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ABC corporation has $1,000,000 to invest in marketable

Resolved Question:

ABC corporation has $1,000,000 to invest in marketable securities. The corporation is choosing between the following three securities: Greenville county tax free municipal bonds yielding 7%, AB corporation bonds yielding 11.5% and ABC preferred stock with a dividned of 10%. The corporate tax rate is 35%. What is the after tax return on the best option after tax? Detail needed
Submitted: 9 years ago.
Category: General
Expert:  Scott replied 9 years ago.

Hi there!

Let's compute the returns after 1 year, including taxes.

Tax free bonds:

No tax!

(NNN) NNN-NNNN1.07 = $1,070,000

Corp bonds:

Full tax!

(NNN) NNN-NNNN1.115-1000000*0.115*.35 = $1,074,750

Pref stock:

Only 30% of the income is taxed at the 35% tax rate! (That's because of the "Dividends-Received Deduction". Reference: http://www.investopedia.com/terms/d/dividendreceiveddeduction.asp)

(NNN) NNN-NNNN1.1-1000000*0.1*0.35*0.30 = $1,089,500

The preferred stock looks to be the best option.

Let me know if you have any questions,

Scott

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