Cost of Capital
This section provides an overview of the cost of capital, flotation costs, debt cost, preferred stock cost, and common stock cost. It also gives examples that show why WACC is important.
Cost of Preferred Stock
Learning Objectives
- Understand the components of preferred stock.
- Explain how preferred stock is a part of the weighted average cost of capital.
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 rps.
Dps is the dividend from preferred stock, Pps is the price of preferred stock.
Equation 12.3 Cost 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 rps?
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
- 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 rps?
- Why is there no tax-adjustment made to our calculation of preferred stock?