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Assume that ABC Inc. is considering an investment in the preferred stock of IBM Corporation. The...

Assume that ABC Inc. is considering an investment in the preferred stock of IBM Corporation. The preferred stock is currently selling for $100 per share with a $4.50 annual dividend. ABC Inc. anticipates a one-year holding period and expects to sell the stock at $100. The corporation is at a 40% average tax rate and the annual interest rate is 8%. Calculate the after-tax rate of return.

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Answer #1

Before-tax rate of return = (Expected selling period - Current selling price + Annual Dividend)/Current selling price

Before-tax rate of return = (100 - 100 + 4.50)/100

Before-tax rate of return = 4.50/100

Before-tax rate of return = 0.045

Before-tax rate of return = 4.50%

After-tax rate of return = Before-tax rate of return * (1 - Tax rate)

After-tax rate of return = 0.045 * (1 - 0.40)

After-tax rate of return = 0.045 * 0.60

After-tax rate of return = 0.027

After-tax rate of return = 2.7%

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