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a firm's preferred stock pays an annual dividend of $4, and the stock sells for $71. flotation costs for new issuances of preferred stock are 4% of the stock value. what is the after-tax cost of preferred stock if the firm's tax rate is 33%?

Answer :

The after tax cost of the preferred stock would be  5.86%

How does this occur?

  • The declared yearly dividend amount paid on each share of preferred stock, divided by the stock's current market value, represents the cost of preferred stock.
  • The cost of preferred stock is always greater than the cost of debt because interest payments on debt are tax deductible while dividends are not.

After tax cost of preferred stock = Dividend / (Stock Price * (1 - Flotation Cost)

After tax cost of preferred stock = 4 / (71 * (1 - 4%)

After tax cost of preferred stock = 4 / 68.16

After tax cost of preferred stock = 5.86%

* Tax doesn't effect the Cost of preferred stock

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