Question

If a company's preferred stock has a sinking fund that calls for the retiring 5 percent of the initial issue of preferred stock each year at par, how would the cost of preferred stock change and be handled in the WACC calculation?

Answer 1

If company's preferred stock has a sinking fund that calls for retiring 5% of initial issue of preferred stock each year at par, the cost of retirement is to be recorded while calculation of weighted average cost of capital.

The cost of retirement is a charge for the company and hence it would increase the overall cost of preferred stock because even though it will reduce the number of total preferred stock, but it will still increase the overall cost of preferred stock.

Retirement of preferred stock will lead to to decline in overall weightage of preferred stock but it will increase the overall cost of preferred stock so company will have to record it as expense.