Question

A firm has the following preferred stocks outstanding:  

     

PFD A: $40 annual dividend, $1,000 par value, no maturity

PFD B: $95 annual dividend, $1,000 par value, maturity after twenty-five years

If comparable yields are 9 percent, what should be the price of each preferred stock?

Answer 1

Calculation of Price of preferred stocks:

PFD A:

Given in question, PFD A has no maturity, i.e. It is irredeemable preferred stock.

We know that, in case of irredeemable preferred stock price can be calculated as:

[Where,

P₀ = Price of Preferred Stock

Dividend= Annual Dividend = $ 40

K_p = Comparable yields = Investor's expectation = 9%]

Therefore, P₀ = $ 444.44 = Price of PFD A*

*Additional Info: Here, the price of preferred stock is less than the par value because the annual dividend percentage (4%) is less than the investor's expectation/comparable yields (9%).

PFD B:

Given in question, PFD B matures after 25 Years, i.e. It is a redeemable preferred stock.

We know that, in case of redeemable preferred stock price can be calculated as:

[Where,

P₀ = Price of Preferred Stock

D = Annual Dividend = $ 95

K_p = Comparable yields = Investor's expectation = 9%

MV = Maturity Value = $ 1000**

n = Number Of years to maturity = 25 years

PVAF = Present Value Annuity Factor

PVF = Present Value Factor]

**As no additional info is given on maturity value, it is always assumed to be at par.

(using calculator)

P₀ = 1049.11

Therefore, P₀ = $ 1049.11 = Price of PFD B