Calculate the cost of preferred stock from annual dividend, price, and flotation costs.
Stock Parameters
Input dividend and market pricing details
Formula: Cost of Preferred Equity
r_p = D_p / (P_0 × (1 - F))
The cost of preferred stock (r_p) is calculated by dividing the annual dividend (D_p) by the net price received by the issuer. The net price is the current market price (P_0) minus flotation costs (F).
Preferred stock is a "hybrid" security. It holds a middle ground between the safety of bonds and the growth potential of common stock, and its cost calculation reflects this unique position.
Preferred stock is an equity ownership stake that pays a fixed dividend. It is "preferred" because these dividends must be paid out before any dividends can be paid to common shareholders.
In the event of bankruptcy, preferred shareholders claim assets after bondholders but before common shareholders. This lower risk profile (relative to common stock) usually results in a lower cost of capital than common equity.
The Perpetuity Formula
Since preferred stock generally has no maturity date (it lasts forever), we value it using the Perpetuity Formula:
Price = Dividend / Rate
Rearranging to find the Cost (Rate):
Rate = Dividend / Price
Accounting for Flotation Costs
When a company issues new stock, it pays fees to investment bankers (underwriting fees, legal fees). These are called Flotation Costs.
Because the company receives less money than the investor pays, the effective cost to the company is higher. We adjust the denominator to reflect the "Net Proceeds".
The Tax Disadvantage
Unlike interest payments on debt, preferred dividends are not tax-deductible for the issuing company.
If a company pays 8% on debt, and has a 25% tax rate, the effective cost is 6%. If a company pays 8% on preferred stock, the effective cost is a full 8%. This is why companies often prefer issuing debt over preferred stock.
Frequently Asked Questions
Common questions about Preferred Stock
Why is it called a "hybrid" security?
It behaves like a bond (fixed payments, sensitivity to interest rates) but is technically equity (no maturity, lower bankruptcy priority, dividends can be suspended without default).
Does the cost change over time?
Yes. Since the dividend is fixed, the "Cost" (yield) fluctuates inversely with the market price. If interest rates rise, preferred prices fall, and the cost rises.
What if the preferred stock is callable?
If the stock is likely to be called (redeemed) by the issuer, calculation similar to "Yield to Call" on a bond is more appropriate than the perpetuity formula.
Is preferred stock cheaper than common stock?
Usually, yes. Preferred shareholders take less risk (guaranteed fixed dividend, liquidation priority) than common shareholders, so they accept a lower return.
Do flotation costs apply to retained earnings?
No. Flotation costs only apply when issuing new securities. They are irrelevant for calculating the cost of existing preferred stock in the market.
What is Cumulative Preferred Stock?
If a company misses a dividend payment, it accumulates in "arrears" and must be paid in full before any dividends can be paid to common shareholders. This lowers the risk (and cost) slightly.
How does this fit into WACC?
WACC = (Weight_Equity × Cost_Equity) + (Weight_Debt × Cost_Debt × (1-t)) + (Weight_Preferred × Cost_Preferred). Note there is no (1-t) tax adjustment for preferred.
Why would investors buy preferred stock?
It offers higher yields than bonds and more stability than common stock. Corporations also get a tax break (DRD) on dividends received from other companies.
Can the cost be negative?
No. Dividends and prices are positive figures.
What is "Par Value"?
The face value (usually $25 or $100) on which the dividend percentage is calculated. Liquidation preference is also usually set at Par.
Summary
The Cost of Preferred Stock Calculator computes the required return for hybrid equity investors.
It correctly handles the perpetuity nature of preferred dividends and the impact of issuance fees.
Use this metric as a key input for accurate Weighted Average Cost of Capital (WACC) modeling.
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Calculate the cost of preferred stock from annual dividend, price, and flotation costs.
How to use Cost of Preferred Stock Calculator
Step-by-step guide to using the Cost of Preferred Stock Calculator:
Enter your values. Input the required values in the calculator form
Calculate. The calculator will automatically compute and display your results
Review results. Review the calculated results and any additional information provided
Frequently asked questions
How do I use the Cost of Preferred Stock Calculator?
Simply enter your values in the input fields and the calculator will automatically compute the results. The Cost of Preferred Stock Calculator is designed to be user-friendly and provide instant calculations.
Is the Cost of Preferred Stock Calculator free to use?
Yes, the Cost of Preferred Stock Calculator is completely free to use. No registration or payment is required.
Can I use this calculator on mobile devices?
Yes, the Cost of Preferred Stock Calculator is fully responsive and works perfectly on mobile phones, tablets, and desktop computers.
Are the results from Cost of Preferred Stock Calculator accurate?
Yes, our calculators use standard formulas and are regularly tested for accuracy. However, results should be used for informational purposes and not as a substitute for professional advice.