Question

Suppose your company needs to raise $10 million to construct a new office building at an expanded manufacturing site. As CFO, you plan to raise the money by selling a new issue of preferred stock. You expect it to sell for $85 per share and pay a dividend of $3.40 per share. It will cost 2.75% to issue the stock. Between the time that your underwriters get the stock into the market, inflation spikes from 2% expected to 4%. Prior to the inflation increase, what is your company's cost of capital?

Answer 1

The company's cost of capital prior to the inflation increase is 6%.

Step-by-step explanation:

The cost of capital is the rate of return that a company needs to earn on its investments in order to maintain the current value of its stock. It is the minimum rate of return required by investors to compensate for the risk they are taking by investing in the company. In this case, the company plans to raise $10 million by selling a new issue of preferred stock. The stock is expected to sell for $85 per share and pay a dividend of $3.40 per share. Based on this information, we can calculate the cost of capital using the dividend discount model:

Cost of Capital = (Dividend / Stock Price) + Growth Rate

Dividend = $3.40 per share, Stock Price = $85 per share, and Growth Rate = 2%

Cost of Capital = ($3.40 / $85) + 2% = 0.04 + 0.02 = 0.06 or 6%

Prior to the inflation increase, the company's cost of capital is 6%.