Question

Companies that have preferred stock outstanding promise to pay a stated dividend for an infinite period. Preferred stock is treated like a perpetuity if the payments last forever. Preferred stocks are considered to be a hybrid of a common stock and a bond. For example, one of the major differences between preferred shares and bonds is that the issuing companies can suspend the payment of their preferred dividends without throwing the company into bankruptcy. However, similar to bonds, preferred stockholders receive a fixed payment—their dividend—before the company’s residual earnings are paid out to its common stockholders and, as with common stock, preferred stockholders can benefit from an appreciation in the value of the firm’s stock securities. Consider the following case of International Imports (I2): International Imports (I2) pays an annual dividend rate of 10.40% on its preferred stock that currently returns 13.94% and has a par value of $100.00 per share. What is the value of I2’s preferred stock?

Answer 1

$74.61

Step-by-step explanation:

The computation of the value of the preferred stock is shown below:

Value of the preferred stock = Annual dividend ÷ Return on the stock

where,

Annual dividend

= Par value × Annual dividend rate

= $100 × 10.40%

= $10.40

And, the return on the stock is 13.94%

So, the value of the preferred stock is

= $10.40 ÷ 13.94%

= $74.61