Question

Question: The treasurer of Kelly Bottling Company (a corporation) currently has \(150,000 invested in preferred stock yielding 8 percent. He appreciates the tax advantages of preferred stock and is considering buying \)150,000 more with borrowed funds. The cost of the borrowed funds is 13 percent. He suggests this proposal to his board of directors. They are somewhat concerned by the fact that the treasurer will be paying 5 percent more for funds than the company will be earning on the investment. Kelly Bottling is in a 35 percent tax bracket, with dividends taxed at 20 percent.

c. Should the treasurer proceed with his proposal?

Short answer

Answer

The treasurer should not proceed with the proposal as the after-tax cost of borrowing is more than the after-tax income.

Step-by-step solution

Step-by-step solutionStep 1: Meaning of treasurer

A treasurer is a person who is responsible for the treasury of the organization. This person is responsible for managing the liquidity and finance of an organization.

Decision regarding the proposal

The after-tax income is $11,280 and the after-tax cost of borrowing is $12,675. Since the after-tax income is less than the after-tax cost of borrowing, so the treasurer should not accept this proposal.