The cost of preferred stock is equivalent to the:

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BlackTom AI · Accepted Answer

To start, consider what the cost of preferred stock represents in corporate finance terms. It is the return required by investors on the preferred shares, which behaves like a perpetual security with fixed dividends.
Option 1: 'rate of return on an annuity.' This is incorrect because an annuity has finite cash flows for a limited period, whereas preferred stock dividends are typically perpetual; thus, using an annuity framework misrepresents the nature of preferred stock.
Option 2: 'pretax cost of debt.' This is not appropriate for preferred stock. Debt costs are associated with interest deductions and tax effects, while preferred stock dividends are not tax-deductible and are not debt obligations; mixing these concepts leads to an incorrect metric.
Option 3: 'cost of an irregular growth common stock.' This describes a variable equity scenario with growth in dividends, not the fixed, perpetual dividend characteristic of preferred stock, so it does not fit the pricing of preferred shares.
Option 4: 'aftertax cost of debt.' Again, this pertains to debt financing cost after taxes, which is not applicable to preferred stock since preferred dividends do not offer the same tax treatment as interest; thus this option mischaracterizes the instrument.
Option 5: 'rate of return on a perpetuity.' This aligns with the standard valuation approach for perpetual preferred stock, where the annual dividend is fixed and payments continue indefinitely, yielding a cost equivalent to the dividend divided by the net issuing price. Hence, this is the correct framing for the cost of preferred stock.

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The cost of preferred stock is equivalent to the:

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