Question

Preferred stock A pays dividends quarterly. Preferred stock B pays dividends annually. All else equal, which will have the higher value?

A

B

A=B

Answer 1

Stock A has higher value as the cashflow from the Stock A received quaterly and where Stock B pays dividend annually so cashflow received late compare to stock A.

We take one example to understand.

For example stock A provide the dividend 2.5 per quarter mean yearly pay 10 and where stock pay dividend of 10 annually and cost of capital of say required return or investor can earn return at 12% p.a.

To compare it we require to compare dividend value at same point of time so here Stock A pays dividend at quarterly and Stock B pays dividend annualy so we find out future value of quarterly dividend received. (or in simple word so here if investor received dividend from stock A and invest it and able to earn return on that dividend at 12% p.a. then)

Value of dividend for qtr-1 = 2.50 x (1+ 0.12x9/12) = 2.50 x 1.09 = 2.725

Value of dividend for qtr-2 = 2.50 x (1 +0.12x6/12) = 2.50 x 1.06 = 2.650

Value of dividend for qtr-3 = 2.50 x (1 +0.12x3/12) = 2.50 x 1.03 = 2.575

Value of dividend for qtr-4 = 2.50 x (1 +0.12x0/12) = 2.50 x 1.00 = 2.500

So total value of dividend at the end of year = 2.725 + 2.650 + 2.575 + 2.500 = 10.45

Value of dividend received after end of year from Stock B = 10

So we find out the value of equity by discounting at require rate of return 12 %

Stock A = 10.45/0.12 = 87.08333 or say 87.08

Stock B = 10/0.12 = 83.33333 or say 83.33

So by this example we conclude that quarterly dividend pays stock have higher value compare to stock pay dividend annual if all other things equal.