Firms that carry preferred stock in their capital mix want to not only distribut

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 ABC Telecom Inc. ABC Telecom Inc. has preferred stock that pays a dividend of $6 per share and sells for $100 per share. It is considering issuing new shares of preferred stock. These new shares incur an underwriting (or flotation) cost of 2.7%. How much will ABC Telecom Inc. pay per share to the underwriter? $97.30 $2.97 $2.70 $87.57 Based on this information, what is ABC Telecom Inc.'s cost of preferred stock capital? 5.24% 4.94% 6.17% 5.55%

Explanation / Answer

Part 1

Payment to Underwriter = price x underwriter’s fees

                                                = 100 x 2.70%

                                                = 2.70

Part 2

Cost of preferred stock = annual dividend/ (price- floatation cost)

                                                = 6 / (100-2.70)

                                                = 6.17%

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