According to the CFI, the cost of preferred stock to the company is the price it pays in return to the income it gets from issuing and selling the stock. In other words, it is nothing but the amount of money the company pays out in dividends to its stockholders divided by the sum it receives from issuing the stock.
Explanation:
Preferred stock has the features of both stocks and bonds, and their valuation is different from common shares. Investopedia states that the owners of preferred stock are also the owners of the company in proportion to the stocks they hold, in the same way as common shareholders.
Preferred shares, however, are different from common shares, as they reserve a preferential claim on the company’s assets, so in case of a bankruptcy, the preferred shareholder is paid before common shareholders. Preferred shareholders also receive fixed payments (i.e., dividends) each quarter, month, or year in a similar way as bonds issued by the company. The dividend usually equals a percentage of the share price, serving as a steady source of income for a shareholder.
It is possible to calculate the value of preferred stocks (kp) if its dividend is fixed. The following formula can be applied: kp = Dp/ Ppfd. In the formula, kp refers to the cost of preferred stock, while Dp is the cost of preferred dividends paid out by the company, and Ppfd is the price of a preferred share at issue.
For example, the electronics company has the preferred stock at the price of $20 per share with the annual dividend payment of $2, therefore, the formula would be kp = $2/ $20 = 0.1 (or 10%), where the cost of preferred stock is 10%.
