This is “Cost of Preferred Stock”, section 12.3 from the book Finance for Managers (v. 0.1).
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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
Falcons Footwear has 2 million shares of preferred stock selling for $85/share. Its annual dividend is $7.50. What’s the rps?
Typically the cost of preferred stock is higher than the after-tax cost of debt. This is because of both the tax deductibility of interest and the fact that preferred stock is riskier than debt.