Question

19. What is the cost of preferred stock for a firm with a $50 par value, a 7% dividend rate, a share price of $58 and as flotation cost? (5) 16. What are the expected return and standard deviation of the possible returns below? (10) Economy Probability Return Good 0.60 25% Bad 0.40 -15% 17. What is the cost of common stock if its beta is 1.5 and market and risk-free returns are 11% and 2%, respectively? (5)

Answer 1

Answer(15):

Cost of preferred stock = Fixed dividend / Net proceeds

Fixed dividend = Par value * % of dividend

Fixed dividend: 50*7% = $3.5

Net proceeds = Market price - Floating cost

Net proceeds: 58 - (5% of 58) = 55.1

Cost of preferred stock = 3.5 / 55.1

Cost of preferred stock = 6.35%

Answer(16): Calculating Expected return-

Economy	Probability	Return	Expected return
Good	.60	.25	.15
Bad	.40	-.15	-.06
Total portfolio return			.09

Total expected portfolio return = 9%

Answer(17): From CAPM-

Cost of equity (Re) = Rf + Beta (Rm-Rf)

Where; Rf is risk free return, Rm is market return

Given: Rf = 2%, Beta = 1.5, Rm = 11%

Re = .02 +1.5 (.11-.02)

Re = .155 or 15.5%