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Diao Corporation is estimating its cost of preferred stock
Diao Corporation is estimating its cost of preferred stock. It has outstanding a $100 face value issue that pays a $11 annual dividend and is currently selling for $105.00. Diao would pay a 5% flotation cost to issue new preferred stock and pays income taxes at a 21% rate.
a) Determine the preferred stock investors' required rate of return
b) Determine the cost of a new issue of preferred stock to Diao Corporation.
Expert Solution
a) Computation of Preferred Stock Investors' Required Rate of Return:
Required Rate of Return = Annual Dividend / Current Stock Price
= $11/$105
Required Rate of Return = 10.48%
b) Computation of Cost of a New Issue of Preferred Stock to Diao Corporation:
Cost of New Preferred Stock = Annual Dividend/(Current Stock Price*(1-Flotation Cost))
= $11/($105*(1-5%))
= $11/($105*95%)
= $11/$99.75
Cost of New Preferred Stock = 11.03%
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