Which of the following statements regarding the cost of preferred stock is accurate?

• A. The cost of preferred stock is calculated by dividing the annual preferred dividend by the net proceeds from the issuance of preferred shares.
• B. The cost of preferred stock is always lower than the cost of debt because preferred dividends are tax-deductible.
• C. The cost of preferred stock is based on the market value of common stock.
• D. The cost of preferred stock includes the effect of stock splits and stock dividends.

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of the cost of preferred stock. The cost of preferred stock represents the return required by investors who purchase preferred shares. It is calculated based on the annual preferred dividend and the net proceeds from issuing preferred shares.
2. Step 2: Recall the formula for calculating the cost of preferred stock. The formula is: $\frac{D}{P}$, where $D$ represents the annual preferred dividend and $P$ represents the net proceeds from the issuance of preferred shares.
3. Step 3: Evaluate the accuracy of each statement provided in the problem. For example, preferred dividends are not tax-deductible, so the statement claiming that the cost of preferred stock is always lower than the cost of debt due to tax deductibility is incorrect.
4. Step 4: Consider the relationship between preferred stock and common stock. The cost of preferred stock is not based on the market value of common stock; it is specifically tied to the preferred dividend and issuance proceeds.
5. Step 5: Analyze the effect of stock splits and stock dividends. These typically impact common stock rather than preferred stock, so the cost of preferred stock does not include these effects. The accurate statement is the one describing the formula for calculating the cost of preferred stock.