Question

An investor with a required rate of return of​ 7% should be willing to pay a maximum of​ $16.35 for a share of preferred stock whose first dividend of​ $1.50 per share will be paid in 5 years. (True or False)

Answer 1

The investor should be willing to pay a maximum of $16.35 for a share of preferred stock. The present value of the first dividend of $1.50 that will be paid in 5 years is approximately $1.03. Therefore, the statement is False.

Step-by-step explanation:

The investor should be willing to pay a maximum of $16.35 for a share of preferred stock. To determine this, we need to calculate the present value of the first dividend of $1.50 that will be paid in 5 years.

Using the formula for calculating present value, we can calculate:

1. Future Value (FV) = $1.50
2. Rate of Return (r) = 7% or 0.07
3. Number of Periods (n) = 5

Plugging these values into the formula:

Present Value (PV) = FV / (1 + r)^n

PV = $1.50 / (1 + 0.07)^5

PV ≈ $1.03

Since the investor's required rate of return is 7%, they should be willing to pay a maximum of approximately $1.03 for a share of preferred stock with a first dividend of $1.50 per share to be paid in 5 years. Therefore, the statement is False.