Question

An issue of preferred stock is paying an annual dividend of $1.25. The growth rate for the firm’s common stock is 5.5%. What is the preferred stock price if the required rate of return is 7.5%?

Answer 1

The price of the preferred stock, paying an annual dividend of $1.25 with a required rate of return of 7.5%, is approximately $16.67 per share.

Step-by-step explanation:

To calculate the price of preferred stock given an annual dividend, a growth rate for the firm’s common stock, and the required rate of return, we use the dividend discount model. In this case, the growth rate of the common stock isn’t relevant for the preferred stock valuation, as preferred dividends are typically fixed. The price of the preferred stock can be found by dividing the fixed annual dividend by the required rate of return.

Using the given numbers, the annual dividend is $1.25 and the required rate of return is 7.5%. Thus:

Price of Preferred Stock = Dividend / Required Rate of Return

Price of Preferred Stock = $1.25 / 0.075
Price of Preferred Stock = $16.67

The final answer is that the price of the preferred stock should be approximately $16.67 per share.