Because the dividends on preferred stock are not deductible for tax purposes, the effect of income taxes is ignored. Thus, the relevant calculation is to divide the $10 annual dividend by the quantity of funds received at the time the stock is issued. In this case, the funds received equal $96 ($101 selling price ? $5 underwriting fee). Thus, the cost of capital is 10.4% ($10 ÷ $96).
Because the 6.2% figure can be obtained only by treating the dividends as deductible.
Because the 4.2% figure can be obtained only by incorrectly treating the dividends as deductible.
Because 10% can be obtained only by basing the calculation on par value instead of funds received.
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