Hi guys, need help with the question from the sample exam:
A company is planning a new issue of $100 par preferred stock with a 12% dividend. The preferred stock can be sold for 95% per share and the company must pay flotation costs of 5% of the market price.
The after tax cost of p.s. is closest to:
A. 8.0%
B. 12.6%
C. 13.3%
Correct answer is C.
The explanation here is that the cost of p.s. is calculated as (100*0.12)/(95*1.05) = 13.3%
I calculated as (100*0,12)/95 = 12.6% , assuming that flotation costs are deducted from preferred stock proceeds already.
Why do they multiply the proceeds from the issue by 1.05?
I would deduct selling price for flotation cost, thus
(100*0.12)/(95*(1-0.05)) = 13%
As I found above you added 5% cost to selling price.
Flashback is correct. It is subtracted from the selling price of 95. Not sure what aydarm’s book says as that formula does not even give you 13.3% as stated (I assume he meant to hit / instead of * and it works?)
Flashback is correct, substract that 5% from the proceeds.
You will rise 95 per share and will spend 5% of each share as a flotation cost, so it is 95 * (1 - 0.05) = 90.25 net proceeds.
Consider impact of flat transaction cost simply as tax impact, doesn’t matter which subject creates this flat cost, goverment or someone else…