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Garnet Corporation is considering issuing risk free debt or risk free preferred stock The tax rate on interest income is 32 and the tax rate on dividends or capital gains from preferred stock is

Garnet Corporation is considering issuing risk-free debt or risk-free preferred stock. The tax rate on interest income is 32%, and the tax rate on dividends or capital gains from preferred stock is 20%. However, the dividends on preferred stock are not deductible for corporate tax purposes, and the corporate tax rate is 36%.
a. If the risk-free interest rate for debt is 6%, what is the cost of capital for risk-free preferred stock?
b. What is the after-tax debt cost of capital for the firm? Which security is cheaper for the firm?
c. Show that the after-tax debt cost of capital is equal to the preferred stock cost of capital multiplied by (1 - t*).

Jun 09 2021 View more View Less

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