A firm has an issue of preference share that pays an annual dividend of $2.00 per share and currently is selling for $18.50 per share.Finally, the firm's marginal tax rate is 34%.This firm's cost of financing with new preference share is

Question

Quizplus · Accepted Answer

The cost of financing with new preference share is calculated using the formula:

Cost of financing = Annual dividend / Net proceeds from sale of preference share

To find the net proceeds from the sale of preference share, we need to subtract underwriting fees and flotation costs from the selling price:

Net proceeds = Selling price - Underwriting fees - Flotation costs

Assuming underwriting fees and flotation costs are 2% of the selling price, we have:

Net proceeds = $18.50 - 0.02($18.50) = $18.14

Now we can calculate the cost of financing:

Cost of financing = $2.00 / $18.14 = 0.110 or 11.0%

Since the firm's marginal tax rate is 34%, we can adjust the cost of financing using the formula:

After-tax cost of financing = Cost of financing x (1 - Marginal tax rate)

After-tax cost of financing = 0.110 x (1 - 0.34) = 0.0726 or 7.26%

Therefore, the closest answer is C) 10.81%.

A Firm Has an Issue of Preference Share That Pays