Question

Hettenhouse Company's perpetual preferred stock sells for $102.50 per share, and it pays a $9.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC?

Answer 1

Answer:

The company's cost of preferred stock for use in calculating the WACC is 9.65%

Explanation:

For computing the cost of preferred stock, the following formula should be used which is shown below

= Annual dividend based on preferred stock ÷ (Price per share × Flotation cost)

where,

Flotation cost = 1- rate

                      = 1- 4% = 0.96

= $9.50 ÷ ($102.50 × 0.96)

= $9.50 ÷ $98.4

= 9.65%

The flotation cost should be deducted because it is a one time expense. Thus, it would be minus from price per share.

Hence, the company's cost of preferred stock for use in calculating the WACC is 9.65%