Since 70 percent of preferred dividends received by a corporation is excluded from taxable income, the component cost of equity for a company which pays half of its earnings out as common dividends and half as preferred dividends should, theoretically, be
Cost of equity = rs(0.30)(0.50) + rps(1 - T)(0.70)(0.50).

Question

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The formula provided incorrectly calculates the cost of equity by mixing the tax treatment of preferred dividends with the cost of equity. The cost of equity should be calculated using the expected return on equity, not by adjusting for tax exclusions on dividends.

Since 70 Percent of Preferred Dividends Received by a Corporation