Preferred-share valuation and the feature table
◈ 8 cardsA perpetuity with a name: a straight preferred is worth its annual dividend over the required return; the inverse reads the implied return off a price; and the bond / preferred / common table places it.
The perpetuity returns
Module 7 priced a level perpetuity as : a payment that never stops is worth the payment over the rate. A straight preferred share is that cash flow — a fixed dividend, no maturity, no growth (Lesson 9.5). So its price is:
where is the annual dividend and the return the market requires of this issuer's preferred, given its rating and the level of rates.
Worked example — Maritime Ferries' $1.10 quarterly preferred
Maritime Ferries' preferred pays $1.10 a quarter — =1.10*4 = $4.40 a year. The market requires 5.5 % on preferreds of its quality:
=4.40/0.055 = $80.00
The course prices preferreds annually: the four quarterly payments are summed to one annual dividend and discounted at the annual rate. (Bigel's quarterly-compounding variant is not used.)
The inverse. The market prices the same share at $88.00. What return does that imply? Rearrange: $r = D / P_0$ — =4.40/88 = 5.00 %. For a straight preferred the dividend yield and the implied return are the same number, because there is no growth and no maturity to add anything. A price above 80 means the market now requires less than 5.5 % — rates have fallen or the issuer's credit has improved; the arithmetic is Lesson 10.3's discount/premium logic with a perpetual term.
The feature table
The MCQ places the preferred between its two neighbours:
| Feature | Bond | Preferred | Common |
|---|---|---|---|
| Claim in a wind-up | first (secured), then unsecured | after all debt, before common | residual |
| Payment | interest — contractual | dividend — fixed but discretionary | dividend — if declared, variable |
| Maturity | yes | usually none (unless retractable) | none |
| Vote | none | usually none | one per share |
| Cost to the issuer | interest is tax-deductible | dividend is not deductible | not deductible |
The last row is the one students miss. Because interest is deductible and dividends are paid from after-tax profit, a preferred is a costlier source of capital for the issuer than a bond with the same coupon — which is why an issuer that could borrow usually does, and why the preferred pays a higher stated rate than the same company's debentures. For the holder, the preferred dividend is eligible for the dividend tax credit, which is part of why they accept the discretionary payment.
Recompute
At a required return of 6.5 %: =4.40/0.065 = $67.69 — a higher required rate, a lower price, the same inverse relation as a bond. The two formulas, cold: price = annual dividend ÷ required return; implied return = annual dividend ÷ price.