Firms that carry preferred stock in their capital mix want to not only distribut
ID: 2745672 • Letter: F
Question
Firms that carry preferred stock in their capital mix want to not only distribute dividends to common stockholders but also maintain credibility in the capital markets so that they can raise additional funds in the future and avoid potential corporate raids from preferred stockholders. Consider the case of Globe Corp. The CFO of Globe Corp. has decided that the company needs to raise additional capital. It can sell preferred stock with a $6 dividend per share for $100 per share; however, it will incur a flotation cost of 2.2% per share. After it pays the underwriter, Globe Corp. will receive from each share of preferred stock that it issues. Based on this information, Globe Corp.'s cost of preferred stock isExplanation / Answer
Price of preferred stock = $100
Annual dividend payment = $6
Floatation cost = 2.2%
Floatation cost is 2.2%, so fee paid for underwriting is calculated below:
Fee paid for underwriting = $100 × 2.2%
= $2.20
Fee paid for underwriting is $2.20.
After payment of underwriting fee total proceeds receive from issuance of preferred stock is calculated below:
Total Proceeds received = $100 - $2.20
= $97.80
After payment of underwriting fee total proceeds receive from issuance of preferred stock is $97.80.
b.
Annual dividend paid = $6
Total Proceeds received = $97.80
Cost of preferred stock is calculated below using following formula:
Cost of preferred stock = Annual Dividend paid / Total Proceeds received
= $6 / $97.80
= 6.135%
So cost of preferred stock is 6.135%
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