Question

A corporation in a 40% tax bracket invests in the preferred stock of another company and earns a 5% pretax rate of return. An individual investor in a 20% tax bracket invests in the same preferred stock and earns the same pretax return. The after-tax return to the corporation is ________, and the after-tax return to the individual investor is

Answer 1

The after-tax return to the corporation is __3%______, and the after-tax return to the individual investor is 4%.

Step-by-step explanation:

A. The after-tax return is the return that is earned by the corporation or individual after the deduction of income tax. Since the corporation and the individual are in different tax brackets, you will normally expect them to earn different after-tax returns.

B. Calculation of the after-tax returns:

After-tax return = Pre-tax return minus income tax

1. Corporation = (100% - 40%) x 5% = 3%

2. Individual = (100% - 20%) x 5% = 4%