I need help approaching this problem: Eric comes to you asking for your advice.

Question

I need help approaching this problem:

Eric comes to you asking for your advice. He wishes to invest $20,000 either in a debt security or in an equity investment. His choices are as shown below: (1) Mockingbird Corporation bond, annual coupon rate of 7.50%. (2) City of Colby general obligation bond, coupon rate of 6.00%. (3) Robin Corporation, 7.50% preferred stock (produces qualified dividend income). These alternatives are believed to carry comparable risk. Assuming that Eric is in the 35% marginal tax bracket, which investment alternative could be expected to produce the superior annual after- tax return?

Explanation / Answer

Answer :- Investment alternative (3) i.e., Investing in 7.50 % preferred stock of Robin Corporation will give highest yearly after tax return as compared to other investment alternatives (1) and (2).

Conclusion :- 7.50 % preferred stock of Robin Corporation. (Investment option 3).

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