Consider an example. Assume a share of preferred stock with the following characteristics: Par value $100 Dividend rate 3.0% per year Payment schedule semiannual Maturity date You are analyzing this preferred stock for possible purchase. Your required rate of return on this stock is 5% per year, compounded semiannually. Draw a time line showing the expected dividends for this preferred stock. Calculate the value of this preferred stock based on the required rate of return. Assume that the current market price for this preferred stock is $75 per share. Calculate the expected return based on the market price. Should you invest in the stock? Why or why not? Be sure to use your results from BOTH parts B and C above.
Dividend Valuation
Dividend refers to a reward or cash that a company gives to its shareholders out of the profits. Dividends can be issued in various forms such as cash payment, stocks, or in any other form as per the company norms. It is usually a part of the profit that the company shares with its shareholders.
Dividend Discount Model
Dividend payments are generally paid to investors or shareholders of a company when the company earns profit for the year, thus representing growth. The dividend discount model is an important method used to forecast the price of a company’s stock. It is based on the computation methodology that the present value of all its future dividends is equivalent to the value of the company.
Capital Gains Yield
It may be referred to as the earnings generated on an investment over a particular period of time. It is generally expressed as a percentage and includes some dividends or interest earned by holding a particular security. Cases, where it is higher normally, indicate the higher income and lower risk. It is mostly computed on an annual basis and is different from the total return on investment. In case it becomes too high, indicates that either the stock prices are going down or the company is paying higher dividends.
Stock Valuation
In simple words, stock valuation is a tool to calculate the current price, or value, of a company. It is used to not only calculate the value of the company but help an investor decide if they want to buy, sell or hold a company's stocks.
- Consider an example. Assume a share of preferred stock with the following characteristics:
Par value $100
Payment schedule semiannual
Maturity date
You are analyzing this preferred stock for possible purchase. Your required
- Draw a time line showing the expected dividends for this preferred stock.
- Calculate the value of this preferred stock based on the required rate of return.
- Assume that the current market price for this preferred stock is $75 per share. Calculate the expected return based on the market price.
- Should you invest in the stock? Why or why not? Be sure to use your results from BOTH parts B and C above.
- You are analyzing a share of XYZ Company preferred stock for possible purchase.
Par value $100
Dividend rate 10% per year
Payment schedule quarterly
Maturity date
Your required rate of return for this stock is 6% per year, compounded quarterly. The current market price of the stock is $150 per share.
- Draw a time line showing the expected dividends for this preferred stock.
- Calculate the value of this preferred stock based on the required rate of return.
- Calculate the expected return based on the market price.
- Should you invest in the stock? Why or why not? Be sure to use your results from BOTH parts B and C above.
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