Question

Tempo Corp. will issue preferred stock to finance a new artillery line. The firm's existing preferred stock pays a dividend of $4.00 per share and is selling for $40 per share. Investment bankers have advised Tempo that flotation costs on the new preferred issue would be 5% of the selling price. Tempo's marginal tax rate is 30%. What is the relevant cost of new preferred stock?A) 7.00%B) 7.37%C) 10.00%D) 10.53%E) 15.00%

Answer 1

Answer: Relevant cost of new preferred stock = 10.53%

Explanation:

Given:

Dividend = $4.00 per share

Selling for = $40 per share.

Flotation costs =  5% of the selling price.

Marginal tax rate is 30%.

We can compute the cost of new preferred stocks using the following formula:

$Relevant\ cost\ of\ new\ preferred\ stock =\frac{ Dividend}{Current\ price\ after\ flotation\ Cost}$

$Relevant\ cost\ of\ new\ preferred\ stock =\frac{4}{40-(0.05\times40)}$

∴ Relevant cost of new preferred stock = 10.53%

Therefore, the correct option is (d)