company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? Note: when flotation costs are given as a percentage instead of in dollar terms, the denominator in the formula changes from (P-F) to P * (1-F). Hint: remember that for preferred stock the growth rate of the dividend is zero.

Question

Business

Nikolas Baker

6 March, 22:44

company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? Note: when flotation costs are given as a percentage instead of in dollar terms, the denominator in the formula changes from (P-F) to P * (1-F). Hint: remember that for preferred stock the growth rate of the dividend is zero.

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Answers (1)

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Kolby Leon · Answer 1

The firm's cost of preferred stock is 9.10%

Explanation:

The cost of preferred stock with the flotation of 5% would be the dividend payable by the preferred stock divided by the adjusted current market price (adjusted for flotation cost)

The dividend per year is $8

The adjusted price of the stock=$92.50 * (1-f)

where f is the flotation cost in percentage terms i. e 5%

adjusted price of the stock is = $92.50 * (1-5%) = $ 87.88

Cost of preferred stock=$8/$87.88*100 = 9.10%