According to the general valuation theory, the value of preferred stock is equal to the sum of all
the cash flows generated from the investment, discounted by the investor’s required rate of
return. Because the only cash flow generated from preferred stock is the dividend payment, the
value of a preferred stock equals the present value of all the future preferred stock dividends.
Because a preferred stock is normally nonmaturing, and the dividends are expected to be paid in
equal amounts each year in perpetuity, the value of the preferred stock can be determined simply
by dividing the annual dividend by the required rate of return:
Vps = annual dividend/required rate of return
Vps = D/kps
where:
Vps = value of the preferred stock
D = annual dividend
kps = required rate of return