Use the following information to answer the question below.
CDE Inc.'s current (and optimal) capital structure is 40% debt, 10% preferred stock, and 50% common equity. CDE is in the 40% tax bracket. The company can issue up to $20,000,000 in new bonds at par with a 7% coupon; any subsequent amount must carry a 2% premium to compensate investors for added risk. A new issue of preferred stock would pay an annual dividend of $4.00 and be priced to net the company $50.00 per share after the $3.00 per share floatation cost. The firm has $21,000,000 in retained earnings. CDE's common stock trades at $40.00 per share and the expected dividend on the common stock is 2.00. Floatation costs on common equity issues is $5.00 per share. The company is growing at 7% per year.
-What is the cost of preferred stock?
A) 8.0%
B) 12.5%
C) 20.0%
D) 8.5%

Question

Quizplus · Accepted Answer

The cost of preferred stock is calculated as the dividend divided by the net price per share. Here, the annual dividend is $4.00, and the net price per share is $50.00. Thus, the cost of preferred stock is $4.00 / $50.00 = 8.0%.

Use the Following Information to Answer the Question Below