CFA Practice Question

CFA Practice Question

Company X is planning a new issue of $100 par preferred stock issue with a 10% dividend. The stock can be sold for $92 per share and the company must pay flotation costs of 4% of the market price. Assuming a marginal tax rate of 40%, X's after-tax component cost of preferred stock is closest to:
A. 6.8%.
B. 11.3%.
C. 6.5%.
Explanation: Dividends are not tax deductible. The after-tax component cost of preferred stock: 100 x 0.10 / [92 - (92 x 0.04)] = 11.3%.

User Contributed Comments 7

User Comment
escempep You can also do : 10/(92/1,04)= 0.113
using Rce=Div1/Pcs
km16 why the flotation costs are not after tax? why 100x 0.1 ?
uviolet this is preferred stock not debt. hence no after tax. it is worded to trick us
Marleni i got ticked even as i am repeating "this is cost of preferred not debt though."
SCBAnalyst WHY DO WE SUBTRACT THE FLOTATION COST?
mary11 Company must pay the cost - the company does not get the full 92 dollars.
Friso Are you not allowed to record the flotation cost as a separate expense and have its tax effect? Or capitalize it and get the tax benefit after amortization? I thought it was, who can answer me this?
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