How to calculate preferred dividends

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How to calculate preferred dividends
Preferred shares provide dividend income and are safer than common stock. (Stockbyte/Stockbyte/Getty Images)

Preferred shares are a type of security used by corporations to raise capital. They are "preferred" in the sense that dividends cannot be paid to holders of common stock until preferred stockholders receive their dividends first. Preferred dividends are calculated based on the number of outstanding preferred shares and the dividend per share.

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Capital Structure

A balance sheet financially organises a corporation into assets, liabilities and shareholder equity. The assets of a corporation require funding for purchase. A corporation's capital structure is the mix of liabilities and equity used to fund assets. Liabilities arising from short-term and long-term debt provide corporations funding in return for the payment of interest and the return of principal to lenders. Equity --- composed of common and preferred stock, warrants, retained earnings and additional contributions --- is also used to fund a corporation. Equity is the excess of assets over liabilities.

Features of Preferred Shares

Preferred shares are intermediate between debt and common stock in terms of payout from corporate liquidation. Shareholders usually have no voting rights, and these shares are often convertible into common shares. Most corporations reserve the right to redeem preferred shares for some combination of cash, debt and/or common stock. Participating preferred stock can receive bonus dividends if a company exceeds predetermined financial benchmarks. Preferred shares with embedded calls can be exchanged for shares of a different company.

Dividends

Common stock dividends, if they're paid, enhance the demand for shares by investors looking for a source of income. Preferred shares, though technically categorised as equity, are actually a hybrid of equity and debt. They're debt-like because preferred shares usually pay a relatively large dividend that's similar to interest on bonds; equity because the corporation can suspend preferred dividends without triggering bankruptcy. Cumulative preferred shares must repay any suspended preferred dividends before common stock dividends can resume.

Calculation

Shares * dividend per share = dividend amount.

Preferred share dividends are stated in one of two ways: either as an explicit dollar amount per share or as a percentage of par. Par is the original capital contribution from the issue of preferred shares. The calculated dividend amount is £2,275 for a position of 1,000 preferred shares with a dividend of £2.20 per share. The same dividend amount would be calculated from 1,000 3.5 per cent preferred shares issued at a par value of £65 per share.

Considerations

Corporations that receive preferred share dividends from other corporations pay at most only 15 per cent income tax on these dividends. Individuals don't receive special tax treatment for preferred dividends.

Because preferred dividends must be paid before common stock dividends and thus reduce the cash available for common dividends, preferred dividends must be subtracted from earnings when calculating earnings per share.

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