Wednesday, April 23, 2008

Cost of Preferred Stock

A firm has outstanding preferred stock that has face value of $100 per share and pays a fixed annual dividend of $6.80. Today, the preferred stock's current market price is $97.00. What is the company's cost of preferred stock?

The cost of preferred stock is the dividend yield on the preferred stock. Notice that there is no subscript for the dividend. This is because this preferred stock pays a constant annual dividend.

Rp = D / Po
= $6.80 / $97.00
= 0.0701, or 7.01%

Similar to bonds, preferred stocks are rated in a similar manner. There are published ratings available for subscription on the internet. An alternative way of finding the cost of preferred stock is to observe the required returns on other, similarly rated preferred stock.

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