How to calculate a preferred stock
What does the preferred stock cost?
Preferred stocks are special company stocks that offer additional benefits. The cost of preferred stock depends on the context and to whom the cost applies. Most often the term refers to the cost of the company in issuing the stock. This could also mean the purchase price for the current and future owners of the share. The cost of preferred stock can also be an opportunity cost.
Preferred stocks differ from common stocks in several ways. When it comes to dividend payments, the owners come first. Owners will also get their money back as a priority if the company goes into liquidation. This guarantee of getting some or all of the purchase price back means that preferred stocks are a mix of stocks such as common stocks and debt securities such as bonds.
The cost of the preferred stock to the company is basically the price it pays in return for the income from issuing and selling the stock. In simplest terms, the cost of the dividend paid on the shares is divided by the issue price. In other words, it's the amount the company will pay out in a year divided by the lump sum they received from issuing the stock. That effectively turns the cost into a kind of interest rate that the company pays in exchange for receiving the money from the stock issue. This number could therefore be compared to the interest rate the company would pay if it instead issued bonds to raise funds or simply borrowed it from a financial institution.
For investors, the cost of preferred shares varies after they are issued, just like any other share price. That is, it will be subject to supply and demand in the market. In theory at least, a preferred stock can be considered more valuable than a common stock because it is more likely to pay a dividend and offers a higher level of security should the company fail.
It is also possible to refer to the cost of preference shares more generally. With that in mind, it's the opportunity cost: what you give up when you have the preferred stock. Calculating this cost is much more difficult because it is more hypothetical. One cost would be, for example, that the holder of preference shares usually has no voting rights. Whether this is an important cost factor depends on the individual. Another disadvantage is that the price of the preferred stock may not go up as quickly as that of the common stock. Hence, the cost is the loss of potential profit after the sale.
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