Tempo Corp.will issue preferred stock to finance a new artillery line.The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share.Investment bankers have advised Tempo that flotation costs on the new preferred issue would be 5% of the selling price.Tempo's marginal tax rate is 30%.What is the relevant cost of new preferred stock?
A) 7.00%
B) 7.37%
C) 10.00%
D) 10.53%
E) 15.00%

Question

Quizplus · Accepted Answer

The cost of new preferred stock is calculated as the dividend divided by the net proceeds from the sale of the stock. The net proceeds are the selling price minus flotation costs. The dividend is $4.00, and the selling price is $40. Flotation costs are 5% of $40, which is $2. Therefore, the net proceeds are $40 - $2 = $38. The cost of new preferred stock is $4.00 / $38 = 0.1053 or 10.53%. The tax rate does not affect the cost of preferred stock.