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Compute cost preferred stock

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Unformatted text preview: rate (state and federal combined) is 40%, the after tax cost of debt AT kd = 10%(1­.4) = 6% (show example) 8 Flotation Costs – cost of issuing securities to the general public Accounting Legal Prospectus – (pass out examples) Underwriting (investment banker) Filing Fees (SEC) 2. Compute Cost Preferred Stock Cost to raise a dollar of preferred stock. Required rate kp = Dividend (Dp) Market Price (PP) - F Dp = preferred stock dividend Pp = Market price per share F = flotation costs per share Flotation costs reduce the amount of money you get when you sell preferred stock 10 10 Cost of Preferred Stock Example: You can issue preferred stock with a market price of \$45, and flotation costs of \$3 per share, for a net price of \$42 and if the preferred stock pays a \$5 dividend, The cost of preferred stock: kp = \$5.00 = 11.9% (vs 11.1%) \$42.00 3. Compute Cost of Common Equity Two Types of Common Equity Financing – Retained Earnings (internal common equity) – Issuing new shares of common stock (external common equity) 12 12 3. Compute Cost of Common Equity Cost of Common Equity (Retained Earnings) – Management should retain earnings only if they earn as much as stockholder’s next best investment opportunity of the same risk. – Cost of CommonEquity = opportunity cost of common stockholders’ funds. – Two methods to determine Dividend Growth Model Capital Asset Pricing Model 13 13 3. Compute Cost of Common Equity 3. Compute Cost of Common Equity (Retained Earnings) – Dividend Growth Model kS = D1 +g P0 Ks = cost of internal common equity D1 = the next dividend to be paid Po = the current market price of the stock g = the projected rate of growth of the company 3. Compute Cost of Common Equity Cost of Internal Common Equity – Dividend Growth Model kS = D1 + g P0 Example: Example: The market price (Po) of a share of common stock is \$60. The prior dividend paid (D0) was \$3, and the expected growth rate (g) is 10%. If you are given D0, you must calculate D1 D1 = D0 (1 + g) D1 = 3.00 (1.10) = 3.30 3. Compute Cost of Common Equity 3. Cost of Internal Common Eq...
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