Question

company has preferred stock that can be sold for $28 per share.  The preferred stock pays an annual dividend of 5% based on a par value of $100.  Flotation costs associated with the sale of preferred stock equal $1.50 per share.  The company’s marginal tax rate is 35%.  Therefore, the cost of preferred stock is ________.
Select one:
a.       11.61%
b.      17.86%
c.      18.87%
d.       12.26%

Answer 1

c. 18.87%
Calculation:
Cost of Preferred Stock = (Dividend / Net Proceeds) + Flotation Costs
= (0.05 x 100 / (28 - 1.5) x (1 - tax rate)
= (5 / 26.5) x 0.65
= 0.0943 or 9.43%
Since preferred dividend is an after-tax, the cost of preferred stock before tax = 0.0943 / (1 - 0.35) = 0.1451 or 14.51%
Cost of Preferred Stock after tax = 0.1451 x (1 - 0.35) = 0.1887 or 18.87%