Question

A company's perpetual preferred stock currently sells for $102.50 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?

Answer 1

Answer:

9.10%

Explanation:

The formular for finding the cost of preferred stock is:

rp=Dp/(Pp(1-F))

Preffered stock price (Pp) = $92.50

Preferred dividend (Dp) = $8.00

Flotation cost (F) = 5%

5×100

=0.05

Therefore,

rp= 8.00/(92.50(1-0.05))

rp= 8.00/(92.50(0.95))

rp= 8.00/87.87

rp= 0.0910×100

rp= 9.10%

Thus, the cost of preferred stock is 9.10%

Answer 2

Answer:

8.21%

Explanation:

We can calculate this by the simple formula:

Price*(1 - Flotation cost) = Dividend/Cost of Pref. stock

Hence the formula turns into:

Cost of Pref. stock = Dividend / Price*(1 - Flotation costs)

Cost of Pref. Stock = 8 / 102.50*(1 - 0.05)

Cost of Pref. Stock = 8.21%

Hope this clear things up.

Good luck and cheers.