A firm has $3 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 9% and the preferred stock trades at $95, what is the cost of preferred stock financing?
10.41%
To calculate the cost of preferred stock financing, we need to use the formula:
Cost of preferred stock financing = (Annual dividend payment / Net proceeds from stock sale)
Let's break down the calculation step by step:
1. Calculate the annual dividend payment:
The annual dividend payment can be determined by multiplying the coupon rate by the par value of the preferred stock. In this case, the coupon rate is 9% and the par value of the preferred stock is $100.
Annual dividend payment = Coupon rate * Par value
= 0.09 * $100
= $9
2. Calculate the net proceeds from stock sale:
The net proceeds from stock sale can be calculated by subtracting the stock price from the par value of the preferred stock. In this case, the preferred stock is trading at $95, and the par value is $100.
Net proceeds from stock sale = Par value - Stock price
= $100 - $95
= $5
3. Calculate the cost of preferred stock financing:
Using the formula mentioned earlier, we can now calculate the cost of preferred stock financing:
Cost of preferred stock financing = Annual dividend payment / Net proceeds from stock sale
= $9 / $5
Therefore, the cost of preferred stock financing is $1.80 per share.