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12 April, 07:36

company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock? Note: when flotation costs are given as a percentage instead of in dollar terms, the denominator in the formula changes from (P-F) to P * (1-F). Hint: remember that for preferred stock the growth rate of the dividend is zero.

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  1. 12 April, 08:04
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    The firm's cost of preferred stock is 9.10%

    Explanation:

    The cost of preferred stock with the flotation of 5% would be the dividend payable by the preferred stock divided by the adjusted current market price (adjusted for flotation cost)

    The dividend per year is $8

    The adjusted price of the stock=$92.50 * (1-f)

    where f is the flotation cost in percentage terms i. e 5%

    adjusted price of the stock is = $92.50 * (1-5%) = $ 87.88

    Cost of preferred stock=$8/$87.88*100 = 9.10%
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