Question

Jones Design wishes to estimate the value of its outstanding preferred stock. The preferred issue has an $80 par value and pays an annual dividend of $6.40 per share. Similar-risk preferred stocks are currently earning a 9.3% annual rate of return. a. What is the market value of the outstanding preferred stock? b. If an investor purchases the preferred stock at the value calculated in part a, how much does she gain or lose per share if she sells the stock when the required return on similar-risk preferred stocks has risen to 10.5%? Explain.

Answer 1

a. What is the market value of the outstanding preferred stock?

the market value of the preferred stock = preferred stock dividend / market rate = $6.40 / 9.3% = $68.82

b. If an investor purchases the preferred stock at the value calculated in part a, how much does she gain or lose per share if she sells the stock when the required return on similar-risk preferred stocks has risen to 10.5%?

if an investor purchases the preferred stock at $68.82, but then the market rate increases, the price of the preferred stock will decrease to $6.40 / 10.5% = $60.95 per preferred stock. This means that the investor will lose $68.82 - $60.95 = $7.87 per preferred stock.