Cost of

Preferred Stocks
& Cost of
Common Stocks

Joana E. Rivad, MPA

Subject Instructor
Cost of Preferred Stock
➢ The cost of preferred measures the
cost of financing through the
issuance of preferred shares of
stock.
➢ It is similar to the cost of debt becau
se payments are made annually but
it is different from it in that there is
no maturity date upon which the
payment of the principal is made.
Cost of Preferred Stock
➢ Compare to the cost of debt, this is simpler
because the expected preferred stock dividends
at year 1 are divided by that net proceeds from
the sale of preferred stock. Since dividends are
not tax-deductible expenses, a tax adjustment is
not necessary.
Cost of Preferred Stock
Where:
d1 = dividends to be received in 1 year
Po = proceeds from the sale of preferred stock
F = Flotation Cost

➢ Since new preferred stocks are involved,

the difference of the market price of the
preferred stocks and flotation cost is the
proceeds. The flotation cost is the cost of
issuing new shares of stock.
Example: Sprinkle Doo Corp. issued preferred stocks with an
underwriting cost of 2% per share. The stocks are
expected provide a P6 dividend per share at the
time of issue. They are now selling at the market
for P50 each. What is the cost of preferred stock?
Cost of
Common Stocks
Cost of Common Stock
Several techniques can be used to compute the cost of common stock
equity:

➢ Gordon’s Growth Model

➢ Capital Asset Pricing Model
➢ Bond Plus Approach Model
Gordon’s Growth Model
also known as the constant dividend growth model
✓ based on the current market price of a common stock.
The valuation model is as follows:

✓ The g represents the retained earnings reinvested in the firm.

Gordon’s Growth Model
Gordon’s Growth Model
Issuance of New Common Stock
✓ If a firm decides to issue new shares of stock in the for
m of common stocks, a variable will be added in what is
termed as flotation cost (F).
Gordon’s Growth Model
 Capital Asset Pricing Model
used in finance to theoretically determine the appropriate required
rate of return of the asset
✓ The CAPM formula considers the asset’s sensitivity to no
n-diversifiable risk (also known as systematic risk or mar
ket risk)
✓ it is referred to as beta (β) in the financial industry
✓ The beta measures the volatility of an asset
return in relation to the market portfolio.
Capital Asset Pricing Model

β = 1.0 β = -1.0
Direct relationship Inverse relationship
Capital Asset Pricing Model
Capital Asset Pricing Model
Capital Asset Pricing Model
Bond Plus Approach Model
It is applied by simply adding a risk premium to the firm’s cost
of debt after-tax.
Bond Plus Approach Model
Bond Plus Approach Model
THANK
YOU