Question

when a firm incurs costs fir issuing preferred stock to raise funds, this issuance costs are referred to as

Answer 1

When a firm incurs costs for issuing preferred stock to raise funds, the issuance costs are reffered to as Floatation Costs.

Floatation Costs are the costs incurred by the issuer when it raises fund by issuing new securities like Equity Shares, Preference Shares, Bond etc. Floatation cost is different from the cost incurred in the form of dividend paid to the shareholders.Floatation Cost includes expences incurred by the company at the time of issue like Leagal Charges, Audit Fees, Registration Fees,Accounting Fees etc. Thes charges increase the cost of capital as the Net Proceed from issue is reduced by these costs. Example: A company issues 1000 new 10%Preference shares of $100/-. Company incures cost of $2000 at the time of issue. Solution: Per share floatation cost=2 (i.e.2000/1000).

Net Proceeds from issue of a share=98 (i.e.100-2)

Cost of Prefrence share=Dividend/Net Proceeds*100

=10/98*100

=10.2041%

Hence it is clear from the above that 10% cost has been increased to 10.2041% because of Floatation Cost.

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