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Question
Companies A and B recently established a new jointly owned subsidiary, ABBA Corporation. ABBA now requires $100 million of capital. A and B will supply $40 million of common equity, $20 million each. The remaining $60 million will be raised by using some combination of debt and preferred stock. Which of the following statements is most correct?
a. The interest rate on the debt would be higher if ABBA uses $60 million of debt and $0 preferred than it would be if ABBA uses $30 million of debt and $30 million of preferred.
b. Because 70 percent of preferred stock dividends received are excluded from a corporation's taxable income, (1) most preferred stock is owned by corporations, and (2) frequently a company's bond interest rate is higher than its preferred stock dividend yield.
c. If ABBA's preferred stock were made convertible into its common, the preferred would have a lower dividend yield than if the preferred were nonconvertible.
d. All of the above statements are true.
e. Only answers a and b above are true.
Answer
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