The Harsanyi Corp. is considering four investments. Which provides the highest after-tax return for Harsanyi Corp. if it is in the 21% federal tax bracket? Assume the tax rate on dividends is 15%.
A) Treasury bonds at 5.0%
B) Corporate bonds at 8.0%
C) Municipal bonds at 5.0%
D) Preferred stock at 6.0%
B) Corporate bonds at 8.0%
After-tax return on Treasury bonds = 5% × (1 ? 0.21) = 3.95%
After-tax return on corporate bonds = 8% × (1 ? 0.21) = 6.32%
After-tax return on municipal bonds = 5%
After-tax preferred return = Before-tax preferred stock yield × [1 ? (Tax rate) (Taxable amount of dividends)] = 0.06 × [1 ? (0.15) (0.30)] = 5.73%
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