CFA Level ICorporate IssuersMedium
Brightstar Corp. plans to issue new preferred stock with a stated annual dividend of $6 per share. The preferred shares are expected to sell for $80 per share, but the firm will incur flotation costs of $2 per share. What is Brightstar's cost of preferred stock, net of flotation costs?
- A7.50%
- B7.69%
- C8.11%
- D6.67%
Show answer & explanationAnswer & explanation
Correct answer: B. 7.69%
Net proceeds per share = $80 − $2 = $78. Cost of preferred stock = Preferred dividend / Net issuance price = $6 / $78 = 7.69%. Flotation costs reduce the net proceeds the firm receives, raising the effective cost of preferred financing above the stated dividend yield on the gross price.
Why the other options are wrong
- A. Uses gross price ($80) without deducting flotation cost ($6/80=7.5%), ignoring flotation impact.
- C. Overstates the cost by using an incorrect denominator smaller than net proceeds.
- D. Incorrect — this uses an unrelated price base, not net proceeds.
Cost of Preferred Stock
The cost of preferred stock equals the fixed preferred dividend divided by the net issuance price (market price minus flotation costs).
- Formula: rp = Dp / Net proceeds per share
- Flotation costs reduce net proceeds, increasing effective cost
- Preferred dividends are not tax-deductible, unlike interest on debt
Memory trick: Divide the dividend by what you actually pocket after fees.