St. Joe Trucking has sold an issue of $6 cumulative preferred stock to the publi

Question

St. Joe Trucking has sold an issue of $6 cumulative preferred stock to the public a price of $60 per share. After issuance costs, St. Joe netted $57 per share. The Company has a marginal tax rate of 40 percent.
a. Calculate the after-tax cost of this preferred stock offering assuming that this stock is a perpetuity.
b. If the stock is callable in 5 years at $66 per share and investors expect it to be called at that time, what is the after-tax cost of this preferred stock offering? (Compute to the nearest whole percent.)

Explanation / Answer

(a)    Calculate after-tax cost of this preferred stock offering assuming that this stock is perpetuity:

Preferred Dividend per share = $6

Marginal tax rate = 40%

Cost [ of Preferred Stock = [Preferred Dividend / Stock value per share]

Cost of Preferred Stock (RP) = [D / P0]

D = Fixed Dividend P0 = Current price per share of the preferred stock

Cost of Preferred Stock = [$6 / $57]

Cost of Preferred Stock = 0.10526

After-tax Cost of Preferred Stock = 10.52% (1-40%)

After-tax Cost of Preferred Stock = 0.1052 (0.60)

After-tax Cost of Preferred Stock =0.06312 (or) 6.312%

After-tax Cost of Preferred Stock = 6.312%

(b)   If the Stock is callable in five years at $66 per share and investors expect it to be called at the time, what is the after-tax cost of this preferred stock offering?

Preferred stock callable in five years at $66 per share

Cost of Preferred Stock (RP) = [D / P0]

D = Fixed Dividend P0 = Current price per share of the preferred stock

Cost of Preferred Stock = [$6 / $66]

Cost of Preferred Stock = 0.0909

Cost of Preferred Stock = 9.09%

After-tax Cost of Preferred Stock = 9.09% (1-40%)

After-tax Cost of Preferred Stock = 0.0909 (0.60)

After-tax Cost of Preferred Stock =0.05454 (or) 5.454%

After-tax Cost of Preferred Stock = 5.454%

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