A company’s perpetual preferred stock currently trades at $80 per share and pays a $6.00 annual dividend per share. If the company were to sell a new preferred issue, it would incur a flotation cost of 4%. What would the cost of that capital be?
To calculate the cost of the new preferred issue, we need to consider the dividend yield and the flotation cost.
1. Start by calculating the dividend yield:
Dividend yield = Annual dividend per share / Market price per share
= $6.00 / $80
= 0.075 or 7.5%
2. Next, calculate the flotation cost as a percentage of the market price:
Flotation cost = Flotation cost % * Market price per share
= 0.04 * $80
= $3.20 per share
3. Subtract the flotation cost from the annual dividend per share:
Net annual dividend per share = Annual dividend per share - Flotation cost per share
= $6.00 - $3.20
= $2.80
4. Finally, divide the net annual dividend per share by the market price per share to get the cost of capital:
Cost of capital = Net annual dividend per share / Market price per share
= $2.80 / $80
= 0.035 or 3.5%
Therefore, the cost of the new preferred issue would be 3.5%.
To calculate the cost of capital for the company's new preferred issue, we need to consider the dividend payment and the flotation cost.
The cost of capital is essentially the return a company needs to generate in order to attract investors to its securities. In this case, the cost of preferred capital refers to the return the company needs to offer to investors in its preferred stock.
First, we calculate the cost of preferred capital using the formula:
Cost of Preferred Capital = Dividend / Net Proceeds
The dividend per share is given as $6.00. However, we need to adjust this dividend to reflect the flotation cost. The flotation cost is 4% of the price of the preferred stock, which is $80 per share. Therefore, the flotation cost per share is 4% * $80 = $3.20 per share.
The net proceeds per share can be calculated by subtracting the flotation cost per share from the stock price:
Net Proceeds per Share = Stock Price - Flotation Cost per Share
= $80 - $3.20
= $76.80
Now we can calculate the cost of preferred capital:
Cost of Preferred Capital = Dividend / Net Proceeds
= $6.00 / $76.80
= 0.078125, which is approximately 7.81%
Therefore, the cost of capital for the company's new preferred issue would be approximately 7.81%.