Question

Find the after-tax return to a corporation that buys a share of preferred stock at $38, sells it at year-end at $38, and receives a $4 year-end dividend. The firm is in the 30% tax bracket. Remember: The corporations may exclude 50% of dividends received from domestic corporations in the computation of their taxable income.

Answer 1

Computation of after tax return to the corporation:

Total before tax income	$4
Less: Tax expense	($0.6)
Total after tax income (a)	$3.4
Investment in preference share (b)	$38
After tax return (a/b)×100	8.95%

Notes:

1. The dividend of $4 is the only income to the corporation.

2. Tax expense on dividend income:

Total before tax income	$4
Less: Exempted income ($4×50%)	($2)
Total taxable income	$2
Tax rate	30%
Tax expense ($2×30%)	$0.6

_______×________

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