McKinsey and Sons has a target capital structure that calls for 50% debt, 10% pr
ID: 1175143 • Letter: M
Question
McKinsey and Sons has a target capital structure that calls for 50% debt, 10% preferred stock, and 40% common equity. The firm can issue new 10 year debt with an annual coupon of 9% for $968.606. The firm is in a 35% tax bracket. The firm's preferred stock sells for $80 per share and pays a dividend of $10 per share; however, the firm will only net $77 per share on the sale of new preferred stock. The firm's common equity sells for $45 per share. The firm recently paid a dividend of $2.00 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 11% per year. What is the firm's cost of newly issued preferred stock?
Explanation / Answer
cost of newly issued preferred stock = Dividend /Market price ,net of flotation cost
= 10 / 77
= .1299 or 12.99%