Question

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.

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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