Barnes Air Conditioning Inc. has two classes of preferred stock: floating rate preferred stock and straight (normal) preferred stock. Both issues have a par value of $100. The floating-rate preferred stock pays an annual dividend yield of 5 percent, and the straight preferred stock pays 6 percent. Since the issuance of the two securities, interest rates have gone up by 1.00 percent for each issue. Both securities will pay their year-end dividend today.
a. What is the price of the floating-rate
preferred stock most likely to be? (Do not round
intermediate calculations and round your answer to 2 decimal
places.)
b. What is the price of the straight preferred
stock likely to be? (Do not round intermediate calculations
and round your answer to 2 decimal places.)
(a) Floating Rate Initial Rate = 5 %, Face Value = $ 100, Annual DIvidend = 0.05 x 100 = $ 5
If interest rate rises by 1 %, the floating rate = 5 + 1 = 6 %
New Annual Dividend = 0.06 x 100 = $ 6
Therefore, Preferred Stock Price = New Annual Dividend / New Interest Rate = 6 / 0.06 = $ 100
(b) Straight Preferred Stock Interest Rate = 6% Face Value = $ 100, Fixed Annual Dividend = 100 x 0.06 = $ 6
As this preferred stock has a fixed annual dividend, a change in interest rates will not impact its dividend.
New Interest Rate = 6+1 = 7 %
Therefore, Preferred Stock Price = 6 / 0.07 = $ 85.71
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