Value of Preferred Stock

What is Preferred stock ?

Preferred stock refers to preference share capital issued by a company. Preferred stock holders are paid their dividend dues before any dividend payment is made to Common stock holders. It is due to this preferential privilege that this type of stock is known as preferred stock.

What are the distinct features of preferred stock ?

In the event of liquidation the preferred stock holders are paid their dues before common stock holders.

The enjoy a fixed dividend payment annually, at a predetermined rate unlike common stockholders whose dividend payments are based on the sufficiency of profits in the company.

They do not enjoy voting rights in the matters pertaining to the business of the company.

How do you value preferred stock ?

Value of preferred stock is calculated by dividing the Dividend per share by the discount rate i.e., cost of preferred stock.

This Is a basic formula used for calculation of value of preferred stock. It based on the following assumptions :

   1.The company pays a fixed rate of dividend regularly.

   2.The preferred stock issued does not have a fixed maturity date.

   3.The stock issued is no convertible into equity shares at a later date.

How do you calculate the value of preferred stock ?

The formula for calculating the value of preferred stock is

= Dividend Per Share / Cost of preferred stock

 

Example 1 :  Cash Rich Co.  has preferred stock with a cost of capital of 8 % . The next preferred dividend of $ 5 is due in one year. What is the value of Cash Rich co.’s  preferred stock?

Solution:  The formula for calculating the value of preferred stock is

= Dividend Per Share / Cost of preferred stock


Dividend Per Share = $ 5 per share ;  Cost of preferred stock = 8 % = 0.08  ;

Applying the above values in the formula we have the value of preferred stock as

= $ 5 / 0.08 = $ 62.50

Thus the value of preferred stock is $ 62.50


How to calculate value of preferred stock with growth rate ?

The formula for calculating the value of preferred stock with growth rate is

= Dividend Per Share / ( Cost of preferred stock – growth rate )

 

Example 2 : Cash Rich Co.  has preferred stock with a cost of capital of 8 % and a dividend growth rate of 2 %. The next preferred dividend of $ 6 is due in one year. What is the value of Cash Rich co.’s  preferred stock?

Solution: The formula for calculating the value of preferred stock with a growth rate is

= Dividend Per Share / ( Cost of preferred stock – growth rate ) 

Dividend Per Share = $ 6 per share ;  Cost of preferred stock = 8 % = 0.08  ;                          Growth rate = 2 % = 0.02  ;

Applying the above values in the formula we have the value of preferred stock as

= $ 6 / ( 0.08 – 0.02 )  = $ 6 / 0.06 = $ 100

Thus the value of preferred stock is $ 100

 

 

 

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