Firms that carry preferred stock in their capital mix want to not only distribute dividends to the companys 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.

Consider the case of Purple Lemon Fruit Company

The CFO of Purple Lemon Fruit Company has decided that the company needs to raise additional capital. It can sell preferred stock paying an annual $6 dividend per share for $100 per share; however, it will incur a flotation cost of 2.2% per share.

After it pays the underwriter, Purple Lemon Fruit Company will receive$97.80 from each share of preferred stock that it issues.

Based on this information, Purple Lemon Fruit Companys cost of preferred stock is .

When raising funds by issuing new preferred stock, the company will incur an underwriting, or flotation, cost that the cost of preferred stock. Because the flotation cost is usually expressed as a percentage of price of each share, the difference between the cost of preferred stock with and without flotation cost is enough to not ignore.