Value Calculation of Preferred Stock with Constant Dividend
Question: A firm plans to pay an annual dividend of $7, in its preferred stock, indefinitely. What is one share of this firm’s preferred stock worth today if the average investor requires an annual 14 percent rate of return on similar investments?
A) $50
B) $98
C) $7.98
D) $20.
E) $6.14
To determine the value of a preferred stock that pays a constant dividend indefinitely, you can use the formula for the value of a perpetuity:
The formula for the Value of Preferred Stock:
Value of Preferred Stock= D/r
Where:
D = Annual Dividend
r = Required Rate of Return
Given:
Annual Dividend (D) = $7
Required Rate of Return (r) = 14% or 0.14
Calculation:
Value of Preferred Stock = 7/0.14
Value of Preferred Stock = 50
Answer:
One share of the firm’s preferred stock is worth $50 today.
Explanation:
The value of preferred stock is calculated based on the perpetuity formula since preferred stock typically pays a constant dividend indefinitely. The calculation shows that, given a required rate of return of 14%, the value of a preferred stock with an annual dividend of $7 is $50.
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