Valuation of Preferred Stock Beart Inc. issued preferred stock with a par value of $100 and an annual dividend rate of 8%. What is the value of this stock if the required return is a b. C. d 12% What relationship do you see between price and required return?
Valuation of Preferred Stock Beart Inc. issued preferred stock with a par value of $100 and an annual dividend rate of 8%. What is the value of this stock if the required return is a b. C. d 12% What relationship do you see between price and required return?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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![**Valuation of Preferred Stock**
Bear Inc. issued preferred stock with a par value of $100 and an annual dividend rate of 8%. What is the value of this stock if the required return is:
a. 5%
b. 8%
c. 12%
d. What relationship do you see between price and required return?
---
Explanation:
The value of preferred stock can be determined using the formula for dividend valuation, which is:
\[ \text{Value of Preferred Stock} = \frac{\text{Annual Dividend}}{\text{Required Return}} \]
- **For a 5% required return:**
\[ \text{Value} = \frac{\$8}{0.05} = \$160 \]
- **For an 8% required return:**
\[ \text{Value} = \frac{\$8}{0.08} = \$100 \]
- **For a 12% required return:**
\[ \text{Value} = \frac{\$8}{0.12} \approx \$66.67 \]
**Discussion:**
d. The relationship between the price and required return shows that as the required return increases, the value of the preferred stock decreases. Conversely, as the required return decreases, the value of the stock increases. This inverse relationship is due to the fact that investors demand higher returns for higher perceived risks, which decreases the present value of the future cash flows (dividends).](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F33ec63b3-d389-4ccd-948b-e56250e63ff8%2F1f9dc5cb-6d20-42e3-b302-3d58798d6e1d%2Fcb2e36_processed.png&w=3840&q=75)
Transcribed Image Text:**Valuation of Preferred Stock**
Bear Inc. issued preferred stock with a par value of $100 and an annual dividend rate of 8%. What is the value of this stock if the required return is:
a. 5%
b. 8%
c. 12%
d. What relationship do you see between price and required return?
---
Explanation:
The value of preferred stock can be determined using the formula for dividend valuation, which is:
\[ \text{Value of Preferred Stock} = \frac{\text{Annual Dividend}}{\text{Required Return}} \]
- **For a 5% required return:**
\[ \text{Value} = \frac{\$8}{0.05} = \$160 \]
- **For an 8% required return:**
\[ \text{Value} = \frac{\$8}{0.08} = \$100 \]
- **For a 12% required return:**
\[ \text{Value} = \frac{\$8}{0.12} \approx \$66.67 \]
**Discussion:**
d. The relationship between the price and required return shows that as the required return increases, the value of the preferred stock decreases. Conversely, as the required return decreases, the value of the stock increases. This inverse relationship is due to the fact that investors demand higher returns for higher perceived risks, which decreases the present value of the future cash flows (dividends).
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Given
the par value of stock is $100
the annual dividend rate is 8%.
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