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).

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