A firm pays an annual preferred dividend of $1.9 per share and investors expect a rate of return of 7.8% from this equity issue. The firm is in the 35% tax bracket.
The preferred stock should be trading at:
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A. B. C. D.D
Preferred dividends are not tax-deductible. Hence, no tax adjustment is made while calculating the cost of preferred equity. The price of a perpetuity that pays C per year, at a discount rate of R, equals C/R. Hence, P = 1.9/0.078 = $24.35.