Rollins Corporation is estimating its WACC. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100 preferred stock which pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2, the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant-growth firm which just paid a dividend of $2.00, sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when using the bond-yield-plus-risk-premium method to find rs. The firm's marginal tax rate is 40 percent.
-What is Rollins' cost of preferred stock?
A) 10.0%
B) 11.0%
C) 12.0%
D) 12.6%
E) 13.2%

Question

Quizplus · Accepted Answer

The cost of preferred stock is 12.6%. The formula for the cost of preferred stock is:$$r_p = \frac{D_p}{P_p}$$where:* $$r_p$$ is the cost of preferred stock* $$D_p$$ is the annual dividend on the preferred stock* $$P_p$$ is the current market price of the preferred stockIn this case, the annual dividend on the preferred stock is $12.00 and the current market price of the preferred stock is $100.00. Therefore, the cost of preferred stock is:$$r_p = \frac{12.00}{100.00} = 0.12 = 12.00%$$

Rollins Corporation Is Estimating Its WACC