Given that preference shares have an expected dividend stream of 20 cents in perpetuity and that...

Given that preference shares have an expected dividend stream of 20 cents in perpetuity and that the current market price (cum-dividend) of the preference shares is $2.40, calculate the cost of capital(kp) of these preference shares.

For this question, I am not sure why the answer is 9.09% rather than 8.33% that ive calculated from 0.2/2.4. Kindly explain.

Expert Solution

Information provided:

Preference share dividend= $0.20

Current market price of preference share and dividend= $2.40

Current market price of preference shares= $2.40 – 0.20= $2.20

Cost of preference shares= Preference share dividend/ Current market price of preference shares

= $0.20/ $2.20

= 0.0909*100

= 9.09%

The cost of preference share was not 8.33% since the price of 2.40 includes the market price and preferred dividend. So, dividend needed to be deducted from $2.40 to arrive at the price of the preferred stock.

In case of any query, kindly comment on the solution.

jeff jeffy answered 1 year ago

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