Question

Jumbo Juice's preferred stock pays a constant dividend equal to $4.75 per share. The firm's marginal tax rate is 40 percent. Jumbo Juice incurs a 5 percent flotation cost each time it issues preferred stock. (a) If the firm issues 10,000 shares of preferred stock at $50 per share, how much of the total value of the issue will the firm be able to use (receive)? (b) What is Jumbo Juice's cost of preferred stock? 11-4

Answer 1

Dividend = $ 4.75 per share

Marginal tax rate = 40%

Floatation cost = 5%

A. Firm issues 10,000 shares at $ 50 per share

Floatation cost = 5% of $ 50 = $ 2.5 per preferred stock

Net amount = 10,000 × (50 - 2.5)

= $ 475,000

B. Cost of preference share

$\large r_{ps} = \frac{D_{ps}}{P(1-F)}$

$\large r_{ps} = \frac{4.75}{50(1-0.05)}$

4.75 Tps 47.5

10% ps

Cost of preference share = 10%

Note in case of preference share there is no tax exemption on the dividend paid like debentures.

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