Question: A corporation can invest $10,000 in preferred stock that pays a 6% dividend and does not appreciate in price. The corporation faces a 40% tax rate. Dividends from the stock are eligible for the 70% corporate dividends received deduction. That is, the corporation has to include only 30% of the dividend in its taxable income. This results in an effective tax rate on the dividend of 12% (= .30 × .40). Assume dividend income is reinvested in more 6% preferred stock.
a. Find the after-tax accumulation for this investment after 10 years.
b. Find the annualized after-tax rate of return on this investment after 10 years.
(Exercise adapted from problem written by Richard Sansing, Dartmouth College.)