Understand Finance - Finance Tutorials and Finance How To's

Finding the cost of preferred stock is a really easy task. We’re always going to use the equation below, and there aren’t too many curve balls you can be thrown with this one.

In this equation, D is the dollar value of the dividend, and NP₀ is the net price or in other words, the price minus any floatation costs. That’s it! Let’s check out a sample problem to see just how easy this is.

Sample Problem 1

Cost of Preferred Stock Example Problem

JumboHost has recently issued preferred stock with a $5 dividend. The preferred stock has a $75 par value and sold for $72.25. Floatation costs on this issue were 3% of par. What is JumboHost’s cost of preferred stock?

Solution

This problem gives us $5 for the dollar value of the dividend. They tell us that the price is $72.25. Furthermore, floatation costs are 3% of par value, or $2.25. Your equation should now look like this:

Great! You got the correct answer of 7.14% with only a few minutes of studying! Try another one!

Sample Problem 2

Another Cost of Preferred Stock Problem

GuitarCorp preferred stock has a par value of $50 and currently sells on the market for $56.00. The dividend rate is 7% and floatation costs on this issue amount to $4.00 per share. What is GuitarCorp’s cost of preferred stock?

Solution

This one looks a little different, but we’ll go through the same process. Remember that our equation needs a dollar value for a dividend but this problem is giving us something new called dividend rate. To get the dollar value, simply multiply the dividend rate times the par value. That gives you a dividend of $3.50 per share. Then in our equation, we have price minus floatation costs. These two numbers are both given to you in the problem!

You should have 6.73% as your answer. Easy! Just remember that when you’re given a dividend rate, always multiply by the par value and not the market price! Try the practice problem below to make sure you’ve got the hang of this.

Practice Problem 1

Cost of Preferred Stock Practice Problem

Bats N’ Balls Sporting Goods is looking to calculate their cost of preferred stock. The par value of their preferred stock is $25 and is currently selling for $23.80. The dividend rate is 8% and floatation costs amount to 3% of par. What is the cost of this preferred stock?

Solution

If you think the answer is 8.68%, then you’ve definitely got the hang of this!

Practice Problem 2

Scissor Snips Hair Salon, home of the 1-minute haircut, issued $100 par value preferred stock with a 16% dividend rate. The stock is currently selling at par, and the company paid $8 per share in floatation costs. What is the cost of their preferred stock?

Solution

A 1-minute haircut sounds a little risky. That really explains why their cost of preferred stock that you just got, 17.39% is higher than most.

That’s really enough fun for now, folks. If you have any questions about this tutorial, or you’d just like to meet other finance students, drop a note in the comment section below.