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Chapter 4: Q11-13BP (page 365)

Medco Corporation can sell preferred stock for \(90 with an estimated flotation cost of \)2. It is anticipated the preferred stock will pay $8 per share in dividends.

a. Compute the cost of preferred stock for Medco Corp.

b. Do we need to make a tax adjustment for the issuing firm?

Short Answer

Expert verified

a. Cost of preferred stock is 9.10%.

b. No tax effect.

Step by step solution

01

Definition of cost of capital

The metric determining the minimum return a business entity must generate to cover the cost incurred in the capital project is known as the cost of capital.

02

Cost of preferred stock

Kp(Costofpreferredstock)=DpPp-F脳100=$8$90-$2脳100=9.10%

Step 2:Adjustment for tax

Taxes do not affect the price of preferred stock. The dividend paid to the holder of the preferred stock cannot be deducted as business expenses. Therefore, it does not require any downward tax adjustment.

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