On September 4, 2001, Alabama Power Co. had two issues of ordinary preferred stock that traded on the NYSE. One issue paid $1.30 annually per share and sold for $21.25 per share. The other paid $1.46 per share annually and sold for $23.05 per share. What is Alabama Power's cost of preferred stock? Using the first issue, we calculate that the cost of preferred stock is:

RP =D/P0

=$1.30/21.25

=6.12%

Using the second issue, we calculate that the cost is:

RP =D/P0

=$1.46/23.05

=6.33%

So, Alabama Power's cost of preferred stock appears to be in the 6.1 to 6.3 percent range.

CONCEPT QUESTIONS

a How can the cost of debt be calculated?

b How can the cost of preferred stock be calculated?

c Why is the coupon rate a bad estimate of a firm's cost of debt?