Palmetto Corporation has preferred stock that pays a 9% dividend. If the firm issues new shares, each share will be sold for the $50 par value. Flotation costs will be 3 percent of the stock price. The firm's marginal tax rate is 34 percent. What is the firm's cost of preferred stock financing

The cost of the preferred stock is 9.278%

Explanation:

The preferred stock pays a constant dividend on its par value. The dividend is paid after interest and tax has been deducted thus it gives no tax benefit.

The cost of the preferred stock can be calculated using the following formula.

rp = D / MP (1-flotation cost rate)

Where,

D is the fixed dividend paid on the preferred stock MP is the market price of the preferred stock

The market price of the preferred stock in this case is equal to par as mentioned in the question. Thus, firm's cost of preferred stock is,

rp = (50 * 0.09) / 50 (1-0.03)

rp = 0.09278 or 9.278%