A company has preferred stock with a current market price of $18 per share.The preferred stock pays an annual dividend of 4% based on a par value of $100.Flotation costs associated with the sale of preferred stock equal $1.50 per share.The company's marginal tax rate is 40%.Therefore,the cost of preferred stock is
A) 28.80%.
B) 24.24%.
C) 22.22%.
D) 14.55%.

Question

Quizplus · Accepted Answer

Step 1: Calculate the dividend paid per share:
Dividend = 4% x $100 = $4

Step 2: Calculate the net proceeds after flotation costs:
Net proceeds = $18 - $1.50 = $16.50

Step 3: Calculate the cost of preferred stock using the following formula:
Cost of preferred stock = dividend / net proceeds
Cost of preferred stock = $4 / $16.50
Cost of preferred stock = 0.2424 or 24.24%

Step 4: Adjust for taxes:
After-tax cost of preferred stock = 24.24% x (1 - 0.40)
After-tax cost of preferred stock = 14.55%

A Company Has Preferred Stock with a Current Market Price