Final answer:
Preferred stock that pays a $2.10 annual dividend with a 9% required yield has an intrinsic value of $23.33 per share. Since it sells for $19, it is undervalued, suggesting it may be better to buy more shares rather than sell. This is derived using the perpetuity formula to calculate intrinsic value.
Step-by-step explanation:
When deciding whether to buy more or sell shares, it's crucial to compare the current market price to the intrinsic value of the shares based on the required yield.
The preferred stock pays an annual dividend of $2.10 per share. Using the market's required yield of 9%, the value of the stock can be found using the formula for a perpetuity: Value = Dividend / Required Yield. Hence, the intrinsic value is $2.10 / 0.09 = $23.33 per share.
Given that the preferred stock currently sells for $19 per share, which is less than its intrinsic value of about $23.33, this indicates that the shares are undervalued. As such, it may be a good opportunity to buy more rather than sell.
In the provided example of Babble, Inc., if profits are paid out as dividends and discounted back to their present value using a 15% interest rate, the price per share would be a substantial amount, reflecting the immense future profits expected to be paid out in dividends over the next two years.