What is the Cost of Preferred Stock?

The cost of preferred stock is the stated dividend amount paid annually on each share of preferred stock, divided by the current market price of the stock. These dividends are not tax deductible, so the cost of preferred stock is always higher than the cost of debt – for which interest payments are tax deductible. The cost of preferred stock is usually less than the cost of common stock, for which investors demand an even higher return on investment.

What are the Components of the Cost of Capital?

A business should always know the cost of its preferred stock, since it is one of the three components of its cost of capital. The other two components are as follows:

Cost of debt. The cost of debt is the after-tax effective rate paid by a borrower on its debt. The cost of debt is the least expensive part of the cost of capital, since it is tax deductible.
Cost of equity. The cost of equity is the return that an investor expects to receive from an investment in a business. the formula for the cost of common stock is as follows:
Risk-Free Return + (Beta x (Average Stock Return – Risk-Free Return))