A firm has issued 10 percent preferred stock, which sold for $100 per share par value. The cost of issuing and selling the stock was $2 per share. The firm's marginal tax rate is 40 percent. The cost of the preferred stock is

The cost of preferred stock is 10.2%

Explanation:

The actual amount realized from issuing the preferred of $100 per share par value is the par value less cost of issuing and selling stock of $2 per share, in other words,$98 ($100-$2) was realized per share from the issuance.

Having known the net amount realized, the cost of preferred stock can be calculated as follows:

cost of preferred stock = return on preferred stock/net amount realized

return is 10% of $100 (par value), i. e $10 per share

cost of preferred stock = $10/$98=10.2%

Note that preferred is not tax deductible like debt financing, hence the rate of tax given is not considered in determining the cost of preferred stock.