Cost of Preferred Stock

Preferred stock dividends are not tax deductible to the company who issues them. Preferred stock dividends are paid out of after-tax cash flows so there is no tax adjustment for the issuing company.

When investors buy preferred stock they expect to earn a certain return. The return they expect to earn on preferred stock is denoted r_{ps}.

D_{ps} is the dividend from preferred stock, P_{ps} is the price of preferred stock.


Worked Example: Falcons Footwear

Falcons Footwear has 2 million shares of preferred stock selling for $85/share. Its annual dividend is $7.50. What's the r_{ps}?

Typically the cost of preferred stock is higher than the after-tax cost of debt. This is because of both the tax deductibility of interest and the fact that preferred stock is riskier than debt.

Key Takeaways
  • Preferred stock is a hybrid security - it's both debt and equity.
  • Preferred stock return is calculated as its dividend divided by its price.

Exercises
  1. Calculate the component cost of preferred stock given the following: Company A has $10 million in preferred stock selling for $100 each and pays a dividend of $7.80. What's the r_{ps}?
  2. Why is there no tax-adjustment made to our calculation of preferred stock?
Callback before_footer in local_aigrade component should be migrated to new hook callback for core\hook\output\before_footer_html_generation
  • line 7225 of /lib/moodlelib.php: call to debugging()
  • line 7292 of /lib/moodlelib.php: call to {closure}()
  • line 71 of /lib/classes/hook/output/before_footer_html_generation.php: call to get_plugins_with_function()
  • line 987 of /lib/classes/output/core_renderer.php: call to core\hook\output\before_footer_html_generation->process_legacy_callbacks()
  • line 154 of /mod/book/view.php: call to core\output\core_renderer->footer()