Question

Abc entity has $4.5m of capital which consists of debt, common stock, retained earnings, and preferred stock. the total preferred stock is $500,000 which is composed of 10,000 shares with a par value of $50 each. the current market value of each preferred share is $55. abc pays preferred shareholders a 10% dividend on the par value each year. abc's tax rate is 21%. what is the cost of existing preferred stock?

a. 1%
b. 6.5%
c. 11%
d. 9% .

Answer 1

The cost of existing preferred stock for ABC entity is calculated as the dividend yield, which means dividing the annual dividend by the market price per share. With a $5 annual dividend and a $55 market price per share, the cost of the preferred stock is 9%. Option d.

Step-by-step explanation:

The question asks us to calculate the cost of existing preferred stock for ABC entity based on the given financial information. This cost is actually the dividend yield on the preferred stock which is determined by dividing the annual dividend payment by the current market price per share.

Since the preferred stock has a par value of $50 and pays a 10% dividend, each share receives an annual dividend of $5 (10% of $50). However, the market value of each share is $55, so the cost of the preferred stock is $5 dividend per share divided by the $55 market price, which equals approximately 0.0909. This translates to a percentage of 9%.

Therefore, the correct answer is 9%, which is option d. This is the return investors require on the preferred stock of ABC entity, considering the current market conditions and the dividends paid. Option d.