Question

A firm has issued 10 percent preferred​ stock, which sold for​ $100 per share par value. The cost of issuing and selling the stock was​ $2 per share. The​ firm's marginal tax rate is 40 percent. The cost of the preferred stock is​

Answer 1

Answer:

The cost of preferred stock is 10.2%

Explanation:

The actual amount realized from issuing the preferred of $100 per share par value is the par value less cost of issuing and selling stock of $2 per share, in other words,$98($100-$2) was realized per share from the issuance.

Having known the net amount realized, the cost of preferred stock can be calculated as follows:

cost of preferred stock =return on preferred stock/net amount realized

return is 10% of $100(par value), i.e $10 per share

cost of preferred stock =$10/$98=10.2%

Note that preferred is not tax deductible like debt financing , hence the rate of tax given is not considered in determining the cost of preferred stock.

Answer 2

The cost of preferred stock would be 0.102 or 10.2% as it shows the rate of return for investors' expectations from the company.

The number of preferred stock issued is 10% at the value of ​ $100 at par. The cost incurred while the issuance of stock is $2, which means the net realized value of the stock would be $98.

$100-2\\=98$

The computation of preferred stock would be initiated by deriving the value of return on preferred stock, that is 10% of $100;

$100*\frac{10}{100} \\=10$

Therefore, the cost of preferred stock would be calculated when the return on preferred stock is divided with the net realized value of the stock;

$\frac{10}{98} \\=0.10$

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