Question

Company's perpetual preferred stock currently sells for $127.50 per share, and it pays 8.00 dividend. If it would incur a flotation cost of 5.00% of the issue price, what is the firm's cost of preferred stock?

Answer 1

To calculate the cost of preferred stock, divide the annual dividend by the net price per share, after adjusting for flotation costs. In this case, the cost of preferred stock is 6.6%.

Step-by-step explanation:

The cost of preferred stock can be calculated by dividing the annual dividend by the current market price of the stock, and then adjusting for flotation costs. In this case, the annual dividend is $8.00 and the stock is selling for $127.50. The flotation cost is 5% of the issue price, which is $127.50 * (5/100) = $6.375. Subtracting the flotation cost from the market price gives us the net price per share of $127.50 - $6.375 = $121.125.

Next, we divide the annual dividend by the net price per share to get the cost of preferred stock. So, the cost of preferred stock is $8.00 / $121.125 = 0.066, or 6.6%.