In calculating the cost of capital and preferred stocks, the book asks us if
cost of debt = Dividend/FMV OR
cost of debt = dividend/par value
So for example, let’s say say the Apple issues a share of preferred stock 100 par, the dividend is 8 dollars, and the buyer can now sell it on the open market at 85.
The book claims that we should calculate it is 8/85=9.4% cost.
Wouldn’t the real cost of having preferred stock be related to how much the company took in from the sale of said stock during primary issue, not how much the stock is going for on the secondary market? Why would Apple care how much Joe Average is getting the stock for? They already raised their 100 dollars. Or am I misunderstanding how par value works?
If Apple wants to issue new preferred stock, Joe Average has said that he has to earn a 9.4% yield.
Take it this way - price of pref stock = div / cost of pref stock
this is the cost as of now - if u issue then u bear it. Any previously incurred cost is history as you don’t know wat price apple issued it
So in this case, are you saying that Apple is selling Joe Average the stock for 85 dollars, but recording it as 100 on their books?
thanks for pulling me along in this material, it was the only question I got wrong on the quiz and it’s driving me nuts
They always record stock at par. If they sell it for more or less than par, they record Other Contributed Capital for the difference.
If it’s paying 8% on $100 par and the public wants 9.4%, they have no choice: they cannot sell it for more than $85. They’ll record it at $100 par and Other Contributed Capital of -$15.
What about common stock being sold through an investment bank?
Say for example, Twitter has an IPO and Deutsche Bank is their salesman?
Twitter has 10,000,000 shares with an undetermined value. DB buys 10% of the company (1M shares). DB gives the Twitter founders $20,000,000 for 1M shares (20 bucks each) then on IPO day releases all the shares for $35 each.
How would Twitter’s internal employees calculate K-ec (cost of common equity)