Why book value of preferred stock being used in the solution? In my opinion market value should have been used instead of book value to be consistent.



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question?
JG Enterprises has 50 million shares, trading at $4 a share; the cost of equity is
12%. It has debt with a market value of $ 100 million and a pre-tax cost of debt
of 6%. Finally the company has $100 million in market value of preferred stock;
the preferred shares are trading at $80 a share, with an annual preferred dividend of $6/share. If the marginal tax rate is 40%, estimate the cost of capital
for the firm.


solution:

First, compute the preferred dividend yield, which is also the cost of
preferred stock:
• Preferred dividend yield = $6/80 = 7.5%
• Cost of capital = 12%(200/400)+ 6%(1-.4)(100/400)+7.5%(100/400) =
8.78%

3 Answer(s)


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Yes it is correct

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Where do you see the book value of the preferred stock?

Quotes from Question:

"Finally the company has $100 million in market value of preferred stock;
the preferred shares are trading at $80 a share"

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Priyank,

You are correct.