Question

Which of the following statement is correct?

a. The cost of preferred stock is negatively affected by the issuer's tax rate.

b. An increase in the market value (price) of a preferred stock will increase the cost of preferred stock.

c. Interest expense reduces a firm's tax liability and therefore this reduction in taxes reduces the cost of debt.

d. If market interest rates rise then both the cost of equity and debt will decrease.

e. All the answers are incorrect.

Answer 1

the tax rate does not affect the cost of preferred stock. cost of preferred stock is calculated by annual dividend dividend by current market price of preferred stock. if market price of preferred stock increases then cost of preferred stock decreases.

Interest is considered as expenses for company, so company can deduct interest expenses from taxable income. so,  Interest expense reduces a firm's tax liability and therefore this reduction in taxes reduces the cost of debt.

Option (C) is correct answer.