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Explain the differences between Preferred Stock and Common Stock.  What is the formula to value preferred...

Explain the differences between Preferred Stock and Common Stock.  What is the formula to value preferred stock?

ABC Company preferred stock offers a dividend payment of $6 per year. Investors require a rate of return of 6%. What should be the price or value of this preferred stock?

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Expert Solution

COMMON STOCK REPRESENTS THE OWNERSHIP IN THE COMPANY. THEY HAVE VOTING RIGHTS. ON THE OTHER HAD, PREFERRED STOCK REPRESENTS THE OWNERSHIP BUT DOES NOT CARRY VOTING RIGHTS

PREFERRED STOCK GETS REGULAR DIVIDEND (FIXED) EVERY YEAR. IF NOT PAID IN PREVIUS YEAR, GETS ACCUMULATED AND PAID NEXT YEAR. COMMON STOCK DOES NOT HAVE THIS FEATURE.

WHEN COMPANY IS LIQUIDATED, PREFERRED STOCK HAS PRIORITY OVER COMMON STOCK IN THE SENSE THAT THEY ARE PAID AHEAD OF COMMON STOCK.

PREFERRED STOCK CAN BE REDEEMED BUT COMMON STOCK CAN NOT BE REDEEMED

PREFERRED STOCK HAVE FIXED DIVIDEND SO THEY CARRY LESS RISK, WHERE COMMON STOCK CARRY A MORE RISK AS THEY ARE PAID ONLY IF ANYTHING IS LEFT AFTER PAYING TO OUTSIDERS WHO HAVE LENT THEM MONEY.

RETURN ON CAPITAL GUARANTEED FOR PREFERRED STOCK BUT NOT TRUE FOR COMMON STOCK

The formula to value preferred stock?

AT THE TIME OF ISSUE

kp = DIVIDEND/NET PROCEEDS FROM ISSUE

AFTER THE ISSUE

kp = DIVIDEND/CURRENT MARKET PRICE

ABC Company preferred stock offers a dividend payment of $6 per year. Investors require a rate of return of 6%. What should be the price or value of this preferred stock?

kp = DIVIDEND/CURRENT MARKET PRICE

0.06 = 6/CURRENT MARKET PRICE

CURRENT MARKET PRICE = 6/0.06 = $100 (PRICE OF THS PREFERRED STOCK)

jeff jeffy answered 2 years ago
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