Antonio's Pizzeria has 8 percent preferred stock outstanding that sells for $71 a share. This stock was originally issued at $58 per share. What is Antonio's cost of preferred stock?

Question

Quizplus · Accepted Answer

The cost of preferred stock represents the rate of return required by investors who buy the preferred stock. We can calculate this rate by dividing the annual dividend paid on the preferred stock by its current market value.

The annual dividend paid on the preferred stock can be calculated as:

$58 * 8% = $4.64

Therefore, the cost of preferred stock is:

$4.64 / $71 = 0.065 = 6.5%

However, since the preferred stock was originally issued at $58 per share, we need to adjust the cost of preferred stock to reflect the fact that investors who bought the stock at that price would have a different rate of return than those who bought it at the current market price of $71.

To do this, we can use the following formula to calculate the cost of preferred stock:

Cost of Preferred Stock = Annual Dividend / Net Proceeds

where Net Proceeds = Current Market Value - Flotation Costs

Flotation costs are the expenses incurred by the company when issuing new securities, such as underwriting fees, legal fees, and printing costs.

Assuming that the flotation costs were 5% ($2.90) of the original issue price ($58), the net proceeds from the sale of the preferred stock would be:

$58 - $2.90 = $55.10

Using this figure, we can calculate the cost of preferred stock as:

$4.64 / ($71 - $2.90) = 0.1127 = 11.27%

Therefore, the best choice is C, 11.27 percent.

Antonio's Pizzeria Has 8 Percent Preferred Stock Outstanding That Sells