Question：A company has issued 6% irredeemable preferred shares of $1 each, and 6% irredeemable bonds. The current market value of the preferred shares is $0.75 each and the current market value of the bonds is $96.00 per $100 nominal. The rate of tax is 25%.
What is the cost of the preference shares and the cost of the bonds?
A. Cost of preferred shares 8%, cost of bonds 4.7%
B. Cost of preferred shares 8%, cost of bonds 4.5%
C. Cost of preferred shares 6%, cost of bonds 4.5%
D. Cost of preferred shares 6%, cost of bonds 4.7%
The correct answer is: Cost of the preferred shares is 8%, cost of the bonds is 4.7%.
Cost of preferred shares = (6/75) x 100% = 8%
Cost of bonds = (1 - 0.25) (6/96) x 100% = 4.6875%, say 4.7%.
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