The expected return on preferred stock is 8.74%
In order to raise money, a corporation issues preferred stock. Annual fixed dividends are paid to preferred investors before the corporation distributes dividends to common stockholders.
Face value = $90
Annual dividend, D = $90 x$8.25= $7.425
Current price, P = $85
Let the expected return be rp
rp=D/P
rp=7.425/85
=8.74%
What is the Cost of Preferred Stock?
- The declared yearly dividend amount paid on each share of preferred stock, divided by the stock's current market value, represents the cost of preferred stock.
- The cost of preferred stock is always greater than the cost of debt because interest payments on debt are tax deductible while dividends are not.
- Preferred stock typically costs less than common stock, for which investors expect an even greater return on their investment.
- Since preferred stock is one of the three factors that make up a company's cost of capital, it is important for a corporation to always be aware of this cost.
- The cost of its debt and the cost of its equity make up the other two factors.
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