Question

Burnwood Tech plans to issue some $80 par preferred stock with a 7% dividend. A similar stock is selling on the market for $95. Burnwood must pay flotation costs of 5% of the issue price. What is the cost of the preferred stock?

Answer 1

Answer:

6.20%

Explanation:

Calculation for the cost of the preferred stock

First step is to calculate the Annual Dividend Payment on Preferred Stock

Annual Dividend Payment on Preferred Stock = [7% * $80]

Annual Dividend Payment on Preferred Stock = $5.60

Now let calculate the Cost of Preferred Stock using this formula

Cost of Preferred Stock = [Preferred Stock dividend / Market Price of

Preferred Stock (1-Flotation cost)]

Let plug in the formula

Cost of Preferred Stock = [($80 * 7%) / $95(1-0.05)]

Cost of Preferred Stock = [$5.60 / $95 (0.95)]

Cost of Preferred Stock = [$5.60 / $90.25]

Cost of Preferred Stock = 0.0620*100

Cost of Preferred Stock = 6.20%

Therefore the cost of the preferred stock is 6.20%