Determining the Cost of Capital: Cost of Preferred Stock

The cost of preferred stock, rp, used in the weighted average cost of capital equation is calculated as the preferred dividend, Dp, divided by the current price of the preferred stock, Pp., tax adjustment is made when calculating rp because preferred dividend aren't tax deductible; so the tax savings are associated with preferred stock.

Quantitative Problem: Barton Industries can issue perpetual preferred stock at a price of $58 per share. The stock would pay a constant annual dividend of $3.60 per share. If the firm's marginal tax rate is 40%, what is the company's cost of preferred stock? Round your answer to 2 decimal places.

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Question

Business

Cooper Atkinson

7 September, 10:38

Determining the Cost of Capital: Cost of Preferred Stock

The cost of preferred stock, rp, used in the weighted average cost of capital equation is calculated as the preferred dividend, Dp, divided by the current price of the preferred stock, Pp., tax adjustment is made when calculating rp because preferred dividend aren't tax deductible; so the tax savings are associated with preferred stock.

Quantitative Problem: Barton Industries can issue perpetual preferred stock at a price of $58 per share. The stock would pay a constant annual dividend of $3.60 per share. If the firm's marginal tax rate is 40%, what is the company's cost of preferred stock? Round your answer to 2 decimal places.

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Answers (1)

Know the Answer?

Serena Bullock · Answer 1

4.48%

Explanation:

To find out the cost of Preferred Stock we simply divide annual dividend by price of share and multiply by 100. So no tax adjustment is made while calculating the cost of preferred stock because preferred stock dividends are not tax deductible as no tax savings are associated with preferred stock

Data provided

Annual dividend = $3.60

Price of share = $58

The computation of cost of preferred stock is shown below:-

Cost of Preferred stock = Annual Dividend : Price of share * 100

= $3.60 : $58 * 100

= 0.0448 * 100

= 4.48%