Mid-South Utilities will sell $10 million of $100 par value preferred stock that will pay an annual dividend of $9.75. Mid-South will receive $93.98 per share after flotation costs. If the issue must be retired in 20 years, what is the cost of the preferred issue?

Question

Quizplus · Accepted Answer

The calculation for the cost of preferred stock is:
Cost of preferred stock = Annual dividend payment / Net proceeds per share
= $9.75 / $93.98
= 0.103722
= 10.37%
However, we need to take into account the fact that there are flotation costs involved. Since Mid-South Utilities will receive $93.98 per share after flotation costs, we need to adjust for this by using the following formula:
Cost of preferred stock = Annual dividend payment / (Net proceeds per share – Flotation costs per share)
= $9.75 / ($93.98 – $100 / $93.98)
= $9.75 / $0.93459
= 10.437%
= 10.50% (rounded to two decimal places)

Mid-South Utilities Will Sell $10 Million of $100 Par Value