Chapter 7, Problem 5PROB

Summary Introduction

The preferred stock has a par value of $40 and pays an annual dividend of 5%. The stock has a required rate of return of 10% and 8%.

Preferred stock as the name suggest has higher preference over common stock. The preferred stockholders get annual dividends like bond holders and have higher priority. Value of the preferred stock also depends on the dividends paid and the required rate of return on the same.

$\begin{array}{rr}{V}_{pf}& =\frac{D_1}{r_s}\hfill \\ where,\\ {\text{D}}_{\text{1}}& =\text{dividend paid}\hfill \\ {\text{r}}_s& =\text{required rate of return}\hfill \end{array}$