Calculate the after-tax cost of preferred stock for Bozeman-Western Airlines, Inc., which is planning to sell $10 million of $6.50 cumulative preferred stock to the public at a price of $50 a share. Issuance costs are estimated to be $2 a share. The company has a marginal tax rate of 40 percent.
To calculate the after-tax cost of preferred stock, we need to consider the dividend payments, issuance costs, and the effect of taxes.
Step 1: Calculate the annual dividend payment
The annual dividend payment can be calculated as the preferred stock dividend rate multiplied by the par value. In this case, the preferred stock dividend rate is $6.50 per share and the par value is $50. Therefore, the annual dividend payment per share is $6.50.
Step 2: Calculate the total issuance cost
The total issuance cost is the cost per share multiplied by the number of shares issued. In this case, the cost per share is $2 and the number of shares issued is $10 million divided by $50. Therefore, the total issuance cost is $2 multiplied by 200,000 shares, which equals $400,000.
Step 3: Calculate the net proceeds from the preferred stock issue
The net proceeds from the preferred stock issue can be calculated by subtracting the total issuance cost from the total amount raised. In this case, the total amount raised is $10 million and the total issuance cost is $400,000. Therefore, the net proceeds from the preferred stock issue is $10 million minus $400,000, which equals $9.6 million.
Step 4: Calculate the after-tax cost
The after-tax cost can be calculated by dividing the annual dividend payment by the net proceeds, and then multiplying by (1 minus the tax rate). In this case, the annual dividend payment is $6.50, and the net proceeds are $9.6 million. The tax rate is given as 40 percent, so (1 - 0.40) equals 0.60. Therefore, the after-tax cost of the preferred stock is ($6.50 / $9.6 million) multiplied by 0.60.
Performing the calculation, the after-tax cost of the preferred stock for Bozeman-Western Airlines, Inc. is 0.60 multiplied by ($6.50 / $9.6 million), which gives you the final answer.