Question

Tarpon Bay Industries preferred stock pays an annual dividend of​ $2.50 per share. If the​ risk-free rate is​ 2%, the expected return on the market is​ 8%, and Tarpon​ Bay's preferred stock is only​ one-half as risky as the market on​ average, what is the most that an investor should be willing to pay for a share of Tarpon Bay preferred stock​ TODAY?

Answer 1

Cost of preferred stock will be $50

Step-by-step explanation:

We have given annual dividend = $2.50

Risk free return
`R_f=2%` %

Expected return on market
`R_m=8%` %

`\beta =0.5`

Required rate of return
`=R_f+\beta (R_m-R_f)`

=
`=2+0.5 (8-2)=5` %

Price of preferred stock is equal to ratio of dividend and required rate

So preferred stock
`=(2.5)/(0.05)=50`

So cost of preferred stock will be $50