How To Calculate Cost Of Preferred Stock In Excel

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Comprehensive Guide: How to Calculate Cost of Preferred Stock in Excel

The cost of preferred stock represents the return a company must provide to preferred stockholders. Unlike common stock, preferred stock pays fixed dividends, making its cost calculation more straightforward but equally important for financial planning. This guide explains the formula, Excel implementation, and practical considerations for calculating the cost of preferred stock.

Understanding Preferred Stock Cost

Preferred stock combines features of both equity and debt. While it doesn’t require repayment like debt, it does require fixed dividend payments, similar to interest payments. The cost of preferred stock is essentially the discount rate that equates the present value of all future dividend payments to the current market price of the stock.

The Basic Formula

The fundamental formula for calculating the cost of preferred stock is:

Cost of Preferred Stock (K_p) = (D_p / P_n) × 100

Where:

• D_p = Annual dividend payment per share
• P_n = Net proceeds from the sale of preferred stock (issue price minus flotation costs)

Step-by-Step Calculation in Excel

1. Gather Required Data:
   • Annual dividend per share (found in the stock prospectus)
   • Current market price per share
   • Flotation costs (percentage of issue price)
   • Corporate tax rate (preferred dividends are not tax-deductible)
2. Calculate Net Proceeds:

   If flotation costs are 3% and the issue price is $100:

   =100*(1-0.03) → $97 net proceeds

3. Apply the Formula:

   For a $5 annual dividend and $97 net proceeds:

   =5/97 → 0.0515 or 5.15%

4. Consider Tax Implications:

   Unlike interest payments, preferred dividends are not tax-deductible. Therefore, the after-tax cost equals the before-tax cost.

Advanced Considerations

Comparison of Cost Components

Component	Common Stock	Preferred Stock	Debt
Dividend/Interest Requirement	Variable	Fixed	Fixed
Tax Deductibility	No	No	Yes
Maturity Date	None	None (usually)	Yes
Flotation Costs	High	Moderate	Low-Moderate
Typical Cost Range	10-15%	6-12%	4-10%

Excel Implementation Example

Let’s create a practical Excel model:

1. Create input cells:
   • B2: Annual Dividend ($5.00)
   • B3: Current Price ($100.00)
   • B4: Flotation Cost (3%)
   • B5: Tax Rate (21%)
2. Calculate net proceeds in B6:

   =B3*(1-B4)

3. Calculate cost before tax in B7:

   =B2/B6 → Format as percentage

4. Calculate after-tax cost in B8:

   =B7*(1-B5) → For comparison only (same as before-tax for preferred stock)

Common Mistakes to Avoid

• Ignoring Flotation Costs: Always subtract flotation costs from the issue price to get accurate net proceeds.
• Tax Treatment Confusion: Remember that preferred dividends are not tax-deductible, unlike interest payments.
• Using Wrong Dividend Figure: Use the annual dividend amount, not the quarterly amount multiplied by 4 (they might differ).
• Market vs. Issue Price: Use the current market price for existing issues, not the original issue price.

Industry Benchmarks and Statistics

Preferred Stock Cost by Industry (2023 Data)

Industry	Average Cost Range	Average Dividend Yield	Typical Flotation Cost
Financial Services	7.2% – 9.5%	5.8%	2.8%
Utilities	6.5% – 8.2%	5.2%	2.5%
Real Estate (REITs)	8.1% – 10.3%	6.7%	3.2%
Energy	7.8% – 9.7%	6.1%	3.0%
Consumer Staples	6.3% – 7.9%	4.9%	2.3%

According to a 2023 S&P Global report, the average cost of preferred stock across all industries was 7.8%, with financial services representing the largest issuers at 42% of total preferred stock outstanding. The report also noted that flotation costs have decreased by approximately 0.5% over the past decade due to increased competition among underwriters.

When to Use Preferred Stock

Companies typically issue preferred stock in these scenarios:

• Capital Structure Optimization: When the cost of preferred stock is lower than the cost of debt (after tax) or common equity.
• Credit Rating Preservation: Preferred stock doesn’t increase debt ratios like bonds would.
• Acquisition Financing: Often used in mergers and acquisitions to provide stable financing without diluting common shareholders.
• Dividend Policy Flexibility: Allows companies to maintain common stock dividends while raising capital.

Alternative Calculation Methods

For more complex scenarios, consider these variations:

1. Adjustable Rate Preferred Stock:

   Use the current dividend rate rather than a fixed rate. The formula becomes dynamic:

   =Current_Dividend_Rate * Par_Value / Net_Proceeds

2. Convertible Preferred Stock:

   Incorporate the conversion premium into the cost calculation, which typically lowers the effective cost.

3. Cumulative Preferred Stock:

   Account for unpaid dividends that accumulate (important for distressed companies).

Excel Functions for Advanced Analysis

Enhance your Excel model with these functions:

• XNPV: For calculating net present value with irregular dividend payment dates.
• IRR: For determining the internal rate of return if selling the stock at a future date.
• DATA TABLE: For sensitivity analysis on dividend growth rates or flotation costs.
• GOAL SEEK: To determine the maximum flotation cost that keeps the cost of capital below a target threshold.

Authoritative Resources:

• U.S. Securities and Exchange Commission – Preferred Stock Guide
• U.S. SEC Investor.gov – Preferred Stock Definition
• Corporate Finance Institute – Cost of Preferred Stock (Educational Resource)