Question

Calculate the cost of preferred stock for Ohio Valley Power Company, which is planning to sell $100 million of $3.25 cumulative preferred stock to the public at a price of $35 per share. Flotation costs are $2.00 per share. Ohio Valley has a marginal income tax rate of 40%

Answer 1

the cost of preferred stock for Ohio Valley Power Company is 9.85%.

Step-by-step explanation:

The cost of preferred stock is the dividend yield on the preferred stock, adjusted for flotation costs and taxes.

The annual dividend per share of preferred stock is the product of the par value and the coupon rate:

Annual dividend per share = $3.25 * $100 = $325

The net proceeds per share after flotation costs is the difference between the issue price and the flotation costs:

Net proceeds per share = $35 - $2 = $33

The cost of preferred stock is then:

Cost of preferred stock = Annual dividend per share / Net proceeds per share

= $325 / $33

= 9.8485 or 9.85%

To adjust for taxes, we multiply by the after-tax cost of debt:

After-tax cost of debt = pre-tax cost of debt * (1 - marginal tax rate)

= 0 * (1 - 0.4)

= 0

Since the marginal tax rate is higher than the flotation-adjusted cost of preferred stock, there is no adjustment for taxes in this case.

Therefore, the cost of preferred stock for Ohio Valley Power Company is 9.85%.