What Is the Cost of Preferred Stock?
The cost of preferred stock is the rate of return investors require for holding a company's preferred shares, which pay a fixed dividend and rank ahead of common stock but behind debt in the capital structure. Because most traditional preferred stock pays a level dividend in perpetuity, its cost is derived from a perpetuity formula rather than from CAPM or yield-to-maturity math.
The measure feeds directly into the weighted average cost of capital whenever preferred stock is a meaningful slice of a company's financing. Banks, insurers, utilities, and REITs are frequent preferred issuers, so analysts covering those sectors compute this cost regularly, while for most industrial companies the preferred layer is small or absent.
How to Calculate It
The formula is Cost of Preferred = Annual Preferred Dividend / Current Market Price of the Preferred. A preferred share issued at a $100 par value with a 5% coupon pays $5 per year; if it currently trades at $80, the cost of preferred is $5 / $80 = 6.25%. If new shares are being issued, analysts divide by net proceeds after issuance fees, which nudges the cost slightly higher.
Within WACC, the component is weighted by preferred's share of total capitalization: WACC = (E/V) x Cost of Equity + (D/V) x Cost of Debt x (1 − Tax Rate) + (P/V) x Cost of Preferred. Note that the preferred term carries a tax shield of zero because dividends are paid out of after-tax income, unlike interest expense. Convertible or floating-rate preferreds require adjustments, since conversion features and rate resets change the expected cash flows.
Why It Matters
The cost of preferred stock almost always lands between the cost of debt and the cost of equity, reflecting its middle position in the priority waterfall. Preferred holders get paid before common shareholders and usually enjoy cumulative dividends, but they sit behind lenders and lack the upside of common equity. That ordering is a classic interview check: if a candidate's cost of preferred comes out below the after-tax cost of debt, something in the inputs is off.
The concept also matters in deal work. In LBOs and growth financings, preferred instruments with 8% to 14% dividends, often payable in kind, are common tools for filling the gap between senior debt and sponsor equity, and pricing them correctly determines how returns split among the parties. Understanding the perpetuity math and the missing tax shield equips analysts to model these structures accurately.
