Question

A company has preferred stock that can be sold for​ $21 per share. The preferred stock pays an annual dividend of​ 3.5% based on a par value of​ $100. Flotation costs associated with the sale of preferred stock equal​ $1.25 per share. The​ company's marginal tax rate is​ 35%. Therefore, the cost of preferred stock is
A) 18.87%.
B) 17.72%.
C) 14.26%.
D) 12.94%

Answer 1

Answer:

B) 17.72%

Explanation:

Cost of preference capital = Share price - Flotation cost

Share price = $21

Flotation Cost = $1.25

Issue price = $21 - $1.25 = $19.75

Tax is not considered while calculating cost of preference capital because dividend is paid to them after tax.

Cost of capital for preference = Dividend/ Issue Price

= $3.5/$19.75 = 17.72%

Therefore, correct option is

B) 17.72%

Answer 2

Answer: Therefore, the cost of preferred stock is 17.72%.

Given:

Selling price (preferred stock) = $21

Annual dividend = 3.5%

Flotation costs = $1.25

We can compute the cost of preferred stock as:

$cost \ of \ preferred \ stock = \frac{annual \ dividend}{( Price\ of \ stock - Flotation\ costs )}$

Cost of preferred stock = 3.5 / ($21 - $1.25)

Cost of preferred stock = 17.72%

The correct option is (b)