Reference no: EM132779370

Problem 1: Interest on bonds is deductible for tax purposes; dividends on preferred share issues are not. Assume that a company can raise $100 million either by assuming bonds promising 12 percent annual interest or by issuing preferred shares, convertible into common shares promising 12 percent annual dividends. The firm expects to continue to have income (in excess of all interest payments) taxable at the rate of 40 percent per year. The company would prefer to:

Option 1: Issue the bonds at a premium
Option 2: Issue the preferred shares
Option 3: Issue the bonds at a discount
Option 4: None of the other alternatives are correct
Option 5: Cannot be determined without considering the underlying risk