Question 2 (7 marks)

A firm with a 40% tax rate has $10 million of pr

eferred shares outstanding (each share has a

$100 par value) that pay a dividend of 10 percent

and are callable at a premium of 6 percent.

Issuing and underwriting ex

penses of $700,000 would have to be incurred.

(a) Assume that current dividend rates have dr

opped to 8 percent. What would be the market

price of a preferred share (if it were

non-redeemable/non-callabl

e/non-retractable)?

2

Question 2 (7 marks)

A firm with a 40% tax rate has $10 million of pr

eferred shares outstanding (each share has a

$100 par value) that pay a dividend of 10 percent

and are callable at a premium of 6 percent.

Issuing and underwriting ex

penses of $700,000 would have to be incurred.

(a) Assume that current dividend rates have dr

opped to 8 percent. What would be the market

price of a preferred share (if it were

non-redeemable/non-callabl

e/non-retractable)?

(b) To what level would the dividend rate (on

comparable issues) have to drop to in order to

make refinancing attractive?

3

(c) Assume that dividend yields have dropped to 8

percent. How many year

s will it take for the

company to recoup the initial refinancing costs?