Question

17) Consider a firm with a marginal tax rate of 50%. The firms cost of preferred stock of 8.43% must be adjusted to an after tax figure of 8.43% * (1-50%), since 50% of dividend payments may be excluded from the taxable income.

A) True

B) False

Answer 1

The answer is False(Option B).

This statement is false because the dividend is not a tax-deductible expense.This means that the tax adjustment for calculating the cost of preferred stocks is not required.

In the above-stated question, the cost of preferred stock shall be 8.43%. We deduct the amount of dividends after the taxes have been paid. 50% of the dividend payment is not excluded from the taxable income. Thus, No adjustment is required since the dividend for this stock is paid after the taxes have been paid. Rather, the floatation costs are considered while calculating the cost of the preferred stock.