# Garnet Corporation is considering issuing risk-free debt or risk-free preferred stock. The tax rate.

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

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*).

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