A company has preferred stock that can be sold for $21 per share.The preferred stock pays an annual dividend of 3.5% based on a par value of $100.Flotation costs associated with the sale of preferred stock equal $1.25 per share.The company's marginal tax rate is 35%.Therefore,the cost of preferred stock is

Question

Quizplus · Accepted Answer

First, we need to calculate the annual dividend payment per share:
$100 par value x 3.5% annual dividend rate = $3.50 per share
Next, we need to adjust for the flotation costs:
$21 market price - $1.25 flotation costs = $19.75 net proceeds per share
Now, we can calculate the cost of preferred stock:
($3.50 dividend payment / $19.75 net proceeds) x 100 = 17.72%
Finally, we need to adjust for taxes, since preferred stock dividends are not tax-deductible:
17.72% / (1 - 0.35) = 27.26%
Therefore, the cost of preferred stock is 17.72%.

A Company Has Preferred Stock That Can Be Sold for $21