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

The cost of preferred stock is calculated using the following formula:
Cost of Preferred Stock = (Dividend Payment - Flotation Costs) / (Net Proceeds Per Share)
Step 1: Calculate the annual dividend payment per share
Dividend Rate = 5%
Par Value = $100
Annual Dividend Payment = 5% * $100 = $5
Step 2: Calculate the net proceeds per share
Selling Price = $28
Flotation Costs = $1.50
Net Proceeds Per Share = $28 - $1.50 = $26.50
Step 3: Calculate the cost of preferred stock
Cost of Preferred Stock = ($5 - $1.50) / $26.50 = $3.50 / $26.50 ≈ 0.1321 = 13.21%
Step 4: Adjust for tax effects
After-tax Cost of Preferred Stock = 13.21% * (1 - Tax Rate) = 13.21% * (1 - 0.35) = 13.21% * 0.65 = 8.5925% ≈ 8.59%
Therefore, the cost of preferred stock (after-tax) is approximately 8.59%, which is closest to option a. 11.61%.