What is WACC with Preferred Stock?
The standard WACC formula accounts for two sources of capital — equity and debt. But many companies, particularly banks, utilities, REITs, and private equity-backed firms, also carry preferred stock as a third distinct capital component. When preferred stock is present, it must be explicitly included in the WACC calculation with its own cost and weight.
The three-component WACC formula is:
+ (P/V x Rp)
+ (D/V x Rd x (1-Tc))
The key distinction is that preferred dividends are not tax-deductible. There is no (1-Tc) adjustment on the preferred stock term. This makes preferred stock more expensive than debt on an after-tax basis, even when the stated dividend yield matches a comparable debt interest rate.
Comparing the Three Capital Components
| Component | Tax Shield? | Priority | Typical Cost |
|---|---|---|---|
| Debt | Yes — deductible | Highest — paid first | 4–8% (after-tax: 3–6%) |
| Preferred Stock | No — after tax | Middle | 5–9% |
| Common Equity | No — after tax | Lowest — paid last | 8–15%+ |
Who Issues Preferred Stock?
Preferred stock is particularly common among US banks and financial institutions, which use it to satisfy regulatory Tier 1 capital requirements without diluting common equity. Large utilities issue preferred stock to raise capital while maintaining their investment-grade debt ratings. REITs frequently tap the preferred market because their high dividend payout ratios limit retained earnings available for reinvestment.
In the private markets, venture capital and private equity investments are almost universally structured as preferred stock — giving investors priority over founders' common shares on dividends and liquidation proceeds.
How Preferred Stock Affects WACC in Practice
The impact of preferred stock on WACC depends on two factors: its cost relative to common equity, and its weight in the capital structure. Since preferred stock typically costs less than common equity, substituting some equity with preferred stock can reduce WACC. However, since preferred stock costs more than after-tax debt, substituting debt with preferred stock will raise WACC.
For most companies, preferred stock represents a relatively small portion of total capital — often 5–15%. Its marginal impact on WACC is real but limited. The larger drivers of WACC remain the equity-to-debt ratio and the cost of each component.
Practical Tips for Calculating Cost of Preferred Stock
Finding preferred stock data requires looking beyond a company's common stock summary. Check the balance sheet for par value and shares outstanding, the notes to financial statements for stated dividend rates, and preferred stock market price from financial data providers such as Bloomberg, Morningstar, or FINRA's bond market data for listed preferred securities.
For companies with multiple preferred share series (Series A, B, C at different dividend rates), calculate a weighted average cost of preferred stock across all series before entering it into this calculator.