2. Tax issues involving preferred stock

QUESTION: All else being equal, is a firm more or less likely to issue preferred stock if its tax rate increases?

A. Doesn't matter

B. Less likely

C. More likely

Consider the case of THC Endowment:

THC Endowment is an institutional investor and owns preferred stocks worth a 20% stake in Hack Wellington Co. Hack Wellington Co. paid out dividends of $214,200 to THC Endowment this year. Hack Wellington Co. had issued perpetual preferred stock with a par value of $100 and pays a(n) 10.20% annual dividend. Investors' required return on Hack Wellington Co.'s preferred stock is 13.67%, and the tax rate for both the companies is 35%. Based on the information given, calculate the following:

QUESTION:

The current market price of Hack Wellington Co.'s preferred stock is:

A. $100.00

B. $111.92

C. $74.62

D. $89.54

QUESTION:

THC Endowment tax liability on its dividend income will be:

A. $74,970

B. $17,993

C. $26,989

D. $22,491

Hack Wellington Co. also issued preferred stock whose dividends varied with the interest rate on the T-bill. Though this feature was intended to keep the price of the stock stable, the fluctuations in the Treasury yields between the dividend rate change dates led to price instability, and several institutional investors reallocated their investments from this preferred stock to other short-term investments.

QUESTION: What kind of preferred stock did Hack Wellington Co. issue?

A. Market auction preferred stock

B. Adjustable rate preferred stock