(Cost of preferred stock) The preferred stock of Gator Industries sells for $34.
ID: 2776048 • Letter: #
Question
(Cost of preferred stock) The preferred stock of Gator Industries sells for $34.63 and pays $2.77 per year in dividends. What is the cost of preferred stock financing? If Gator were to issue 488,000 more preferred shares just like the ones it currently has outstanding, it could sell them for $34.63 a share but would incur floatation costs of $2.82 per share. What are the floatation costs for issuing the preferred share and how should this cost be incorporated into the NPV of the project being financed?
Explanation / Answer
Cost of preferred stock = $2.77 / $34.63
= 8.00%
The floatation costs include expenses like underwriting fees, legal fees and registration fees etc. In the above new issue, the floatation cost is adjusted to the share price such that actual amount raised per share goes down to $31.81 (= $34.63 - $2.82).
The floatation costs are included in the discounting factor alongwith required rate of return which is used to derive the NPV of the project being financed.
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