# Cost of Preferred Stock

Cost of preferred stock is the rate of return required by the holders of a company's preferred stock. It is calculated by dividing the annual dividend payment on the preferred stock by the preferred stock's current market price.

In most cases, the cash flows stream of a preferred stock is a perpetuity because preferred stock has unlimited life and it pays a fixed amount of dividend each period. Value of a preferred stock is essentially the present value of a perpetuity.

$$ PV\ of\ Perpetuity \\= \frac{Periodic\ Payment}{Discount\ Rate} $$

We can modify this relationship to come up with the formula for cost of preferred stock. The discount rate in the above relationship is the rate of return required by the holders of the preferred stock. The periodic payment is the fixed amount equal to the product of the stated percentage rate and the face value of the preferred stock while the present value of the perpetuity is the value of the preferred stock.

## Formula

$$ Cost\ of\ Preferred\ Stock \\= \frac{Annual\ Dividend\ on\ Preferred\ Stock}{Current\ Market\ Price\ of\ Preferred\ Stock} $$

## Example

Wells Fargo & Company has 3,500,000 shares of $1,000 par value non-cumulative series L preferred stock.

They carry annual fixed coupon rate of 7.5%. The preferred stock has a current market price on 29 December 2012 of $1,225.45. Find the cost of preferred stock.

Annual dividend payment = 7.5% of $1,000 = $75 per preferred stock

Cost of preferred stock = annual dividend payment ($75) รท current market price ($1225.45) = 6.12%

Written by Obaidullah Jan, ACA, CFA and last modified on