M & M Motors is financed with the following optimal capital structure:
Source Market Value
Bonds $55,000,000
Preferred Stock $25,000,000
Common Stock $45,000,000
New bonds can be sold at par value ($1,000) with a 9% coupon. Preferred stock with a 10% dividend on a $50 par value can be sold to net $40 per share. The required rate of return to common stockholders, as reflected in the current stock price, is 16%. The current stock price is based on expectations of constant growth of 8% per year and an expected dividend next year of $4.80. Flotation costs for new common stock are $3.00 per share. M & M will have $3,600,000 of earnings available for new investments (within the firm). The company's marginal tax rate is 40%. Calculate M & M's cost of new preferred stock.
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