Question

What are the benefits and features of:

(A) Ordinary annuity

(B) Annuity Due

(C) Perpetuity

The preferred shareholders earn a $2.50 annual dividend (never changed). What is the fair value of the preferred stock if the market premium is 0.15?

Answer 1

1. Ordinary Annuity

• In an ordinary annuity, a series of equal instalments are made at the end of each period. For example, Payments made at the end of each week, month, quarter, semi-annually, and annually. The key point is the payments are made at the END of each Period.
• For Eg. A stock paying

Advantage: The biggest advantage of an annuity is that you will receive an amount for every period. Consider pension policies people prefer to get an annuity, as they will receive money until they are alive. An annuity is majorly used for insurance planning

2. Annuity Due

• An annuity due to to the payments is made at the START of each consecutive period. Payments are made at the start of the month rather than at the end.
• For eg. A fixed deposit paying you interest at the start of each quarter.

3. Perpetuity

• As the name suggests perpetuity means the one with no end. In this type the security. There will be an infinite number of Cash inflows. For Eg. Common Stocks theoretically will pay you the dividend (if declared) throughout the life. there is no maturity date.
• Advantage: You can calculate a fair value of the stock to determine whether it is profitable or not.
• There is no end of the flow of income.

VALUE OF PREFERENCE SHARE
V= D/i V= value, D= Dividend, i= Premium

=$2.50/0.15= 16.67