4. The calculation of the cost of preferred stock

Firms that carry preferred stock in their capital mix want to not only distribute dividends to common stockholders but also maintain credibility in the capital markets so that they can raise additional funds in the future and avoid potential corporate raids from preferred stockholders.

Ten years ago, Purple Lemon Fruit Company issued a perpetual preferred stock issuecalled PS Alphathat pays a fixed dividend of $9.00 per share and currently sells for $100 per share. Purple Lemons management team is considering issuing a second issue of perpetual preferred stock. If the new issuetentatively called PS Betais actually sold, the company will incur an underwriting (or flotation) cost of 5.00%. In addition, the underwriters are anticipating the need to pay a dividend of $17.75 per share to attract new investors, and is expecting to sell the new shares for $98.00 per share.

As a component in Purple Lemons weighted average cost of capital, PS Alpha shares currently exhibit a cost of:

9.00%

10.35%

7.65%

8.55%

If Purple Lemon elects to issue its PS Beta shares, it will pay ____ per share in flotation costs, and will receive net proceeds of ______ per share from its underwriters.

Based on its underwriters best estimates of the issues expected future dividend and market price, the marginal cost of the PS Beta issue is expected to be:

14.30%

16.21%

19.07%

25.74%

Companies _____ make tax adjustments when calculating the (after-tax) cost of preferred stock because preferred dividends ________ tax deductible, so the company bears their full cost.