Cost of Preferred Stock Calculator
Use this calculator to determine the cost of preferred stock (Kp) for a company. This represents the return a company must earn on its investments to satisfy the holders of its preferred stock.
Enter the annual dividend per share and the net price the company received per share (after flotation costs).
Enter Preferred Stock Details
Understanding the Cost of Preferred Stock
What is Preferred Stock?
Preferred stock is a class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred dividends are generally fixed and must be paid before common stock dividends. Unlike common stock, preferred stock typically does not carry voting rights.
Why Calculate the Cost of Preferred Stock?
For a company, the cost of preferred stock is a component of its overall cost of capital (part of the Weighted Average Cost of Capital - WACC). It represents the return required by preferred shareholders, which is a cost to the company for using preferred stock financing.
Cost of Preferred Stock Formula (Kp)
The calculation assumes that preferred stock pays a perpetual, fixed dividend. The formula is straightforward:
Kp = Dp / Np
- Kp = Cost of Preferred Stock
- Dp = Annual Preferred Stock Dividend per Share (in dollars)
- Np = Net Price per Preferred Stock Share (the price received by the company after deducting flotation costs per share)
To express the result as a percentage, the result of the division is multiplied by 100.
Net Price vs. Market Price
It's important to use the *net price* when calculating the cost for the *issuing company*. The net price is the amount the company receives after paying fees to brokers, lawyers, and others involved in issuing the stock (flotation costs). If using the market price, you might be calculating the required return for *investors*.
Cost of Preferred Stock Examples
Click on an example to see the step-by-step calculation:
Example 1: Standard Issuance
Scenario: A company issues preferred stock with an annual dividend of $6 per share. The stock is sold to investors for $100, but flotation costs are $4 per share.
1. Known Values: Annual Dividend (Dp) = $6.00, Gross Price = $100.00, Flotation Costs = $4.00
2. Calculate Net Price: Net Price (Np) = Gross Price - Flotation Costs = $100.00 - $4.00 = $96.00
3. Formula: Kp = Dp / Np * 100%
4. Calculation: Kp = $6.00 / $96.00 * 100%
5. Result: Kp = 0.0625 * 100% = 6.25%
Conclusion: The cost of this preferred stock to the company is 6.25%.
Example 2: Higher Dividend Stock
Scenario: A company issues preferred stock with an annual dividend of $8 per share. The net price received by the company after all costs is $95 per share.
1. Known Values: Annual Dividend (Dp) = $8.00, Net Price (Np) = $95.00
2. Formula: Kp = Dp / Np * 100%
3. Calculation: Kp = $8.00 / $95.00 * 100%
4. Result: Kp ≈ 0.0842 * 100% = 8.42%
Conclusion: The cost of this higher-dividend preferred stock is approximately 8.42%.
Example 3: Stock Issued Below Par
Scenario: Preferred stock with a $100 par value and a 7% dividend rate (meaning $7 annual dividend) is issued. Due to market conditions and flotation costs, the net price received by the company is $90 per share.
1. Known Values: Annual Dividend (Dp) = $100 * 7% = $7.00, Net Price (Np) = $90.00
2. Formula: Kp = Dp / Np * 100%
3. Calculation: Kp = $7.00 / $90.00 * 100%
4. Result: Kp ≈ 0.0778 * 100% = 7.78%
Conclusion: The cost of this preferred stock issued below par is approximately 7.78%.
Example 4: Stock Issued with High Flotation Costs
Scenario: A preferred stock has a $5 annual dividend. It is sold to the public for $50, but flotation costs amount to $5 per share.
1. Known Values: Annual Dividend (Dp) = $5.00, Gross Price = $50.00, Flotation Costs = $5.00
2. Calculate Net Price: Net Price (Np) = Gross Price - Flotation Costs = $50.00 - $5.00 = $45.00
3. Formula: Kp = Dp / Np * 100%
4. Calculation: Kp = $5.00 / $45.00 * 100%
5. Result: Kp ≈ 0.1111 * 100% = 11.11%
Conclusion: High flotation costs increase the cost of preferred stock significantly, to approximately 11.11% in this case.
Example 5: Preferred Stock Trading at a Premium
Scenario: A company's outstanding preferred stock pays a $4 annual dividend. If the company were to issue new preferred stock, the net price received per share is estimated to be $105.
1. Known Values: Annual Dividend (Dp) = $4.00, Net Price (Np) = $105.00
2. Formula: Kp = Dp / Np * 100%
3. Calculation: Kp = $4.00 / $105.00 * 100%
4. Result: Kp ≈ 0.0381 * 100% = 3.81%
Conclusion: When the net price is higher (trading at a premium), the cost of preferred stock is lower, approximately 3.81%.
Example 6: Zero Dividend (Theoretical)
Scenario: *Theoretically*, if a preferred stock had a $0 annual dividend and the net price was $98.
1. Known Values: Annual Dividend (Dp) = $0.00, Net Price (Np) = $98.00
2. Formula: Kp = Dp / Np * 100%
3. Calculation: Kp = $0.00 / $98.00 * 100%
4. Result: Kp = 0 * 100% = 0.00%
Conclusion: A preferred stock with a zero dividend would have a cost of 0%. (Note: Preferred stock is defined by its fixed dividend, so this is highly unusual in practice for calculating Kp, but the math holds).
Example 7: Calculating Net Price Needed
Scenario: A company wants its preferred stock cost to be no more than 7%. If the annual dividend is $5 per share, what is the minimum net price the company must receive?
1. Known Values: Annual Dividend (Dp) = $5.00, Target Kp = 7% (0.07)
2. Rearrange Formula: Kp = Dp / Np => Np = Dp / Kp
3. Calculation: Np = $5.00 / 0.07
4. Result: Np ≈ $71.43
Conclusion: To achieve a cost of 7%, the company must receive a net price of at least $71.43 per share.
Example 8: Using Market Price (Investor's Return)
Scenario: An investor is looking at a preferred stock that pays a $6 annual dividend and is currently trading in the market for $98.
1. Known Values: Annual Dividend (Dp) = $6.00, Market Price (used here as Np proxy for investor) = $98.00
2. Formula: Kp = Dp / Np * 100%
3. Calculation: Kp = $6.00 / $98.00 * 100%
4. Result: Kp ≈ 0.0612 * 100% = 6.12%
Conclusion: The investor's required rate of return (yield) on this preferred stock is approximately 6.12% based on its current market price.
Example 9: Impact of $1 Flotation Cost
Scenario: Preferred stock with a $5 annual dividend is sold for $100 per share, with flotation costs of only $1 per share.
1. Known Values: Annual Dividend (Dp) = $5.00, Gross Price = $100.00, Flotation Costs = $1.00
2. Calculate Net Price: Net Price (Np) = Gross Price - Flotation Costs = $100.00 - $1.00 = $99.00
3. Formula: Kp = Dp / Np * 100%
4. Calculation: Kp = $5.00 / $99.00 * 100%
5. Result: Kp ≈ 0.0505 * 100% = 5.05%
Conclusion: With lower flotation costs, the cost of preferred stock is lower, approximately 5.05%.
Example 10: Preferred Stock issued at a Discount
Scenario: Preferred stock with a $10 annual dividend is issued with a net price to the company of $92 per share.
1. Known Values: Annual Dividend (Dp) = $10.00, Net Price (Np) = $92.00
2. Formula: Kp = Dp / Np * 100%
3. Calculation: Kp = $10.00 / $92.00 * 100%
4. Result: Kp ≈ 0.1087 * 100% = 10.87%
Conclusion: When the net price is lower (issued at a discount), the cost of preferred stock is higher, approximately 10.87%.
Frequently Asked Questions about Cost of Preferred Stock
1. What is the formula for the Cost of Preferred Stock?
The formula is Kp = Dp / Np, where Dp is the annual preferred stock dividend per share and Np is the net price received by the company per preferred share after flotation costs.
2. Why do you use the 'Net Price' instead of the market price?
The 'Net Price' is used because it represents the actual amount of capital the company receives from issuing the preferred stock. The cost of issuing the stock (flotation costs) reduces the proceeds, thereby increasing the effective cost of the capital raised from the company's perspective. Market price is more relevant for investors calculating their yield.
3. Are flotation costs important?
Yes, flotation costs are very important. They reduce the net proceeds the company receives from the issuance. A lower net price (Np) in the formula directly leads to a higher cost of preferred stock (Kp) for the company.
4. How is the cost of preferred stock different from the cost of common stock?
The cost of preferred stock is calculated more simply because the dividend is usually fixed and perpetual. The cost of common stock (Ke) is more complex to estimate, often using models like the Dividend Discount Model or the Capital Asset Pricing Model (CAPM), as common stock dividends are variable and there's capital appreciation potential.
5. How is the cost of preferred stock different from the cost of debt?
Dividends paid on preferred stock are generally *not* tax-deductible for the company, whereas interest payments on debt *are* tax-deductible. This means the after-tax cost of debt is usually lower than the cost of preferred stock, assuming similar risk levels. The cost of debt is calculated as Interest Expense / Net Proceeds * (1 - Tax Rate).
6. What does the resulting percentage mean?
The percentage represents the rate of return that the company effectively pays to its preferred shareholders for the capital they provided, after accounting for the costs of issuing the stock. It is the required rate of return for preferred shareholders.
7. Does this calculation apply if the preferred stock has a maturity date?
The formula Kp = Dp / Np strictly applies to preferred stock that is *perpetual* (has no maturity date). For redeemable or puttable preferred stock with a specific maturity, the calculation is more complex and involves finding the internal rate of return, similar to calculating the yield on a bond.
8. Can the annual dividend be zero?
Theoretically, yes, the dividend input can be zero, resulting in a cost of 0%. However, preferred stock is fundamentally defined by its preference in receiving a fixed dividend payment. Preferred stock with a zero dividend is highly unusual and might be better classified differently or have unique features that require a different valuation approach.
9. Can the net price be zero or negative?
No, the net price must be positive. If the net price were zero or negative, it would imply the company received no capital (or even lost money) from the issuance, making the calculation of a cost meaningless in the traditional sense. The calculator requires a net price greater than zero.
10. Is this cost used in the WACC calculation?
Yes, the cost of preferred stock (Kp) is one of the components used to calculate a company's Weighted Average Cost of Capital (WACC). The WACC includes the cost of debt, the cost of preferred stock, and the cost of common stock, weighted by their proportion in the company's capital structure.
