Question

Consider the case of THC Endowment:

THC Endowment is an institutional investor and owns preferred stocks worth a 20% stake in Scorecard Corp. Scorecard Corp. paid out dividends of $239,400 to THC Endowment this year. Scorecard Corp. had issued perpetual preferred stock with a par value of $100 and pays a(n) 11.40% annual dividend. Investors’ required return on Scorecard Corp.’s preferred stock is 15.28%, and the tax rate for both the companies is 30%. Based on the information given, calculate the following:

	Value
The current market price of Scorecard Corp.’s preferred stock is:	------------
THC Endowment tax liability on its dividend income will be:	-----------

Consider that Scorecard Corp. also issued market auction preferred stock. Which of the following is true about market auction preferred stock?

a. Yield set on the issue after an auction on the preferred stock is the lowest yield sufficient to sell all shares being offered at that auction.

b. Yield set on the issue after an auction on the preferred stock is the highest yield sufficient to sell all shares being offered at that auction.

Answer 1

Solution:

a)Calculation of current market price of Scorecard Corp.’s preferred stock

Market Price=Annual Dividend/Required rate of return on preferrred stock

=($100*11.40%)/15.28%

=$74.61

b)Calculation of Endowment tax liability on its dividend income

Dividend income to Endowment shall be treated as investment income and accordingly taxable at the rate of 30%.Thus Endowment tax liability on its dividend income is;

=Dividend Income*Tax rate

=$239,400*30%

=$71,820

c)The correct answer is :

Yield set on the issue after an auction on the preferred stock is the highest yield sufficient to sell all shares being offered at that auction.