Comparison of the costs of debt and preferred stock (LO3) The treasurer of Riley

Question

Comparison of the costs of debt and preferred stock (LO3) The treasurer of Riley Coal Co. is asked to compute the cost of fixed income securities for her corporation. Even before making the calculations, she assumes the aftertax cost of debt is at least 2 percent less than that for preferred stock. Based on the facts below, is she correct? Debt can be issued at a yield of 10.6 percent, and the corporate tax rate is 35 percent. Preferred stock will be priced at $50 and pay a dividend of $4.40. The flotation cost on the preferred stock is $2.

Explanation / Answer

After tax cost of Debt = cost of Debt( 1 - tax) = 10.6% ( 1 - 0.35) = 6.89% After Tax Cost of preferred Stock = Dividend / Net Proceeds = $4.4 / (50 - 2) = 4.4 / 48 = 9.167% Treasurer assumes the after tax cost of debt is at least 2 percent less than that for preferred stock The difference between Cost of Preferred stock and After tax Cost of Debt = 2.276% Hence,The Treasurer is Correct.

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.