Question

2.A preferred stock promises a steady dividend of $ 4.00. Determine the value of that stock if the required rate of return is 6%. Present financial reasons for that behavior

Answer 1

Formula of value of preferred stock is:

Value of preferred stock = Annual dividend / Required rate of return

Putting the values in the above formula, we get,

Value of preferred stock = $4 / 6%

Value of preferred stock = $66.67.

Financial reasons:

Prereferred stock has the characteristics of both debt and equity. It is equity in the sense that preferred stockholders are owners of the company and have perpetual existence just like common stockholders, but with limited rights. And, it is debt in the sense as preferred stockholders receive fixed rate of annual dividends just as debt holders recieve annual interests. The dividends of preferred stockholders are perpetual in nature. So, their value is the present value of future perpetual dividends.