Allen Corporation can (1) build a new plant that should generate a before-tax return of 10%, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9.00%, all in the form of dividends. (Assume that the preferred stock has a par value of $100 and annual dividends per share = $9; therefore, $9/$100 = annual 9% return.) Assume that Allen’s marginal tax rate is 25%, and that 50% of dividends received are excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen’s effective return on the money invested? Hint: Use the following equation to help you answer this question, After-tax return = Pretax return (1 - T). (Round your final answer to two decimal places.) a. All in FPL preferred stock. b. 60% in the project; 40% in FPL. c. All in the plant project. d. 60% in FPL; 40% in the project. e. 50% in each.
Allen Corporation can (1) build a new plant that should generate a before-tax return of 10%, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9.00%, all in the form of dividends. (Assume that the preferred stock has a par value of $100 and annual dividends per share = $9; therefore, $9/$100 = annual 9% return.) Assume that Allen’s marginal tax rate is 25%, and that 50% of dividends received are excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen’s effective return on the money invested? Hint: Use the following equation to help you answer this question, After-tax return = Pretax return (1 - T). (Round your final answer to two decimal places.) a. All in FPL preferred stock. b. 60% in the project; 40% in FPL. c. All in the plant project. d. 60% in FPL; 40% in the project. e. 50% in each.
Chapter7: Common Stock: Characteristics, Valuation, And Issuance
Section: Chapter Questions
Problem 11P
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Allen Corporation can (1) build a new plant that should generate a before-tax return of 10%, or (2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should provide Allen with a before-tax return of 9.00%, all in the form of dividends. (Assume that the preferred stock has a par value of $100 and annual dividends per share = $9; therefore, $9/$100 = annual 9% return.) Assume that Allen’s marginal tax rate is 25%, and that 50% of dividends received are excluded from taxable income. If the plant project is divisible into small increments, and if the two investments are equally risky, what combination of these two possibilities will maximize Allen’s effective return on the money invested? Hint: Use the following equation to help you answer this question, After-tax return = Pretax return (1 - T). (Round your final answer to two decimal places.)
a. All in FPL preferred stock.
b. 60% in the project; 40% in FPL.
c. All in the plant project.
d. 60% in FPL; 40% in the project.
e. 50% in each.
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