Question

Why is the cost of debt less than the cost of preferred stock if both securities are priced to yield 10 percent in the market? (LO11-3)

Short answer

The interest on debt is a tax-deductible expense that's why the cost of debt is less than the cost of preferred stock.

Step-by-step solution

Preferred Stock

Preferred stock is called preferred stock because it has preferential rights. It means preference share will be paid first and then the common stockholders in case of dividend and assets distribution.

Reason why the cost of debt is less than the cost of preferred stock.

In this case, both debt and preferred stock are priced to yield 10 percent in the market. But the cost of debt is less than the cost of preferred stock because the interest on the debt is a tax-deductible expense for the business.