Question

X-Tech Company issued preferred stock many years ago. It carries a fixed dividend of $8 per share. With the passage of time, yields have soared from the original 15 percent to 18 percent (yield is the same as required rate of return).

a. What was the original issue price? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Original issue price

  

      
  
b. What is the current value of this preferred stock? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

Current value

  

Answer 1

To find out the Value of a Preferred Stock, we use the perpetual cash flow formula, i.e (Cashflow/Rate), in this case, it would be:

Dividend/(Rate of return)

1. Original Issue Price- At the time of Issue, the rate of return expected by the stockholders was 15%, hence the issue price should be

$8/(0.15) or ($8*100/15)= $53.33

2. Current Value of the Stock - Applying the same formula, we get

$8/(0.18) or ($8*100/18) = $44.44

The Rate of return expected by the stockholders has increased from 15% to 18%, this would result in a drop in the Stock Value. The simple reason from this is the cash flow we get from the company is fixed at $8. If the rate of return or yield is at 15%, the value an investor would be ready to shell out would be 53.33 (53.33*15%=$8), if the return increases, he would be willing to pay less because he still gets $8,($44.44*18%=$8).