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19 September, 09:25

A company has preferred stock with a current market price of $18 per share. The preferred stock pays an annual dividend of 4% 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 40%. Therefore, the cost of preferred stock is

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  1. 19 September, 12:10
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    Dividend (D) = 4% x $100 = $4

    Current market price (Po) = $18

    Flotation cost (FC) = $1.50

    Tax rate (T) = 40% = 0.40

    Kp = D

    Po-FC

    Kp = $4

    $18-$1.50

    Kp = $4

    $16.5

    Kp = 0.24 = 24%

    Explanation:

    Cost of preferred stock equals dividend divided by the difference between current market price and flotation cost. Cost of preferred stock is not tax deductible.
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